[00:00:02] 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, April 4th, 2025. I'm Brian Pietrangelo, and welcome to the podcast. We certainly have a lot to discuss today, so I'll get right into the introduction of 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 articles series addressing a relevant topic for investors. 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 two economic releases for you among multiple, but we're going to focus on only those two so we can get to the bigger topic which was the market volatility of the week.

The ISM Services Report and the ISM manufacturing report were released earlier in the week with manufacturing coming in for March in a contractionary phase, and this has been a continuation for roughly the past two years and almost the past four years that manufacturing has been in a contractionary phase relative to that part of the economy. On the other side of the coin, the services sector continued expansion in March and that marks almost five years or 58 consecutive months of expansion in the services side of the economy. So, good news there balancing out the two areas of the report.

The second major news release from an economic perspective was just this morning at 8:30 from the Bureau of Labor Statistics, which showed the new non-farm payroll report indicated 228,000 new nonfarm pay rolls, which - good news - was above estimates and above expectations. However, the downside was that the numbers for January and February combined were revised downward by 48,000 jobs. So again, a little bit of good news, a bit of bad news, they kind of equal out. But nonetheless, they're forward-looking somewhat. They're also backward-looking, somewhat. So, we'll continue to watch this number in terms of the strength of the overall labor market. But again, for now, given all the other news this week, somewhat positive, or at least neutral.

Now let's turn to the big news of the week was certainly the market decline on Thursday and the significant market volatility in reaction to President Trump's imposition of tariffs on Wednesday evening in his press conference. And the market did not take that well relative to not only the U.S. markets, but the global markets in tandem. So, we will have a significant discussion around that today.

Now, let's turn to George and the team to spark the conversation in terms of understanding the tariffs, what they mean, what are they, and what are the implications going forward to not only the economy, but to the markets.

[00:03:07] George Mateyo: So let's start, Brian, by unpacking a lot of things that happened in the last few days or so. I think we probably need to go back just to Wednesday, which is also known as “Liberation Day.” And on that day, it was announced that some new tariffs were being put forth. And frankly, this really surprised everybody. And I think everybody was just shocked by the magnitude, the extent to which these tariffs were applied, and also the drama that's involved.

So, to kind of unpack that a little bit furthermore, I think to some extent we have to acknowledge that there really were two types of tariffs that were announced over the last few days. One of which is called a baseline or universal tariff of 10%. So, all important goods essentially will be levied to a 10% tax, basically. And those tariffs go into effect tomorrow, Saturday, April 5th.

The other notion or the other component of the tariff policy has to do with these things called individualized reciprocal tariffs. And that's kind of a little nebulous term, but it was kind of born out of the idea that I think the administration wanted to focus on tit for tat or reciprocal tariffs, meaning if we get taxed or tariffed by a certain amount, call it 20%, then we would have the right to essentially tariff another country at 20%. So that's kind of a reciprocal tariff.

And I think what really shocked people is that it really wasn't really reciprocal in the sense that what happened is that the administration took a slightly different approach and they didn't base the reciprocal tariffs on tariffs themselves, but rather they based the tariffs on the overall trade deficit between one country and the next, typically our country and another country. And so there's some issues about the validity of that and the methodology that was used, but I think that was one thing that really kind of caused people some panic and some kind of concern in the sense of these numbers got to be really large pretty quickly.

So, what essentially it means, I guess, overall, is that the overall tariff rate, if these are fully implemented, and that's a big, big caveat if they're fully implemented, you know, I think the overall tariff probably moves up to something above or close to 20 percent, which would be kind of close to a hundred year high. So, we haven't seen tariffs this high in over a century. And that really marks a major historic shift. So, people are now scrambling to try and figure out what this means for the economy. Again, the question is whether these things will be implemented alongside the notion of these reciprocal tariffs and this formula that was applied.

There's a lot of subjectivity in terms of how the administration could kind of walk these tariffs back. They could be renegotiated down. They could be actually escalated even further. So again, there's a whole lot more ambiguity and again, I think the market was coming into this thinking there would be some type of clearing event. I heard this phrase “clearing event” used all the time last week and that really didn’t happen, meaning that we saw... some people think there would be some relief of uncertainty, and I think unfortunately we've got more uncertainty in the sense that these reciprocal tariffs now essentially could be moved back and forth and negotiated and added and subtracted pretty easily, which just fuels more uncertainty.

If we think about brass tacks in terms of what it means for the overall economy, as I said a few minutes ago, people are starting to think about what this means for their models around inflation, their thoughts about GDP growth, and the overall headline numbers, again, are pretty wide. So again, I think there's a wide range of outcomes that could certainly ensue going forward. But what it seems to suggest is that on most economic models, the price level of most goods, and again, there's lot of caveats there, but most goods will probably rise about 1% to 2%.

At the same time, most of these economic models that I've seen in some of the forecasts I've read suggest that growth could contract by one to two percent. So if you add that up, and again, kind of coming into this, we've had inflation hovering around two and a half percent. So if we mark inflation up by 150 basis points, one point five percent, you're staring at inflation closer to four percent. And that's, of course, well above the Fed's comfort level and well above their two percent target.

Conversely, if you mark the growth estimates down by 1% or 2%, coming into this, the economy was in decent shape, I would argue. So the economy was growing 2%, 2.5%. But if you have to subtract another percent and a half or two away from that, then you're staring at something close to 1% or less growth for 2025. And that's where I think now we have to start thinking about this, this actually introduced the notion of stagflation or maybe an outright recession. And the market is trying to grapple with that because the market doesn't know, again, how much uncertainty, how long these tariffs will be implemented. I think that's a really key variable. How long do these tariffs go into effect and will they stay in effect? That's just, again, brought with it a lot of uncertainty. And the markets are really kind of struggling to kind of digest that.

So, I think there's also some broad implications around kind of what the administration's trying to accomplish by these things. I think, there is a broader realignment of trade policy that we haven't seen probably in many, many decades, and I think that's also causing some concern. But at the same time, we are starting to see some of the market anticipate this, maybe try to clear some of uncertainty out. It's going to take some time, but I think what we've seen so far right now is we kind of focused on risk assets and particularly those companies and those stocks that have been probably more economically sensitive, companies that actually have more exposure to the overall global supply chains. And at some point, I do think that this is going to be kind of a moment where there could be some quick reversals. So, there may be some policy forcing mechanisms. Maybe we'll talk about that a little bit. But I think there could some clarity at some point, and that could provide some relief rally when we least expect it. So, I think the idea is to try and stay focused, try and say disciplined, try and keep your head on as much as you can amidst this chaotic moment in time. But let's talk about for a second, Steve, kind of what we've seen so far in the equity market and the reaction there, and what you’re thinking about as relates to earnings and the outlook going forward.

[00:08:39] Stephen Hoedt: Well, George, this morning on Friday, you got total panic finally getting into the market, right? I mean, when you look at what's been going on over the last few days, even yesterday, the selling was mostly orderly. But this morning, we've seen the Cboe Volatility Index spike to over 45 intraday. That's the highest level since the Japanese yen situation last August.

We've got put call ratio spiking to over two this morning, and we've got ten to one breadth negative and 95% volume negative this morning. So we're finally getting to a place where the market might be so bad that it's good in terms of, you know, finally getting the move that we needed to see or the flush that we needed to see out of the market to get capitulation and to get a tradable low put in.

That said, you know when you look at those fundamentals: the fundamentals are going to take quite a while to catch up to where the market is. It's very similar to the COVID situation or, I hate to draw the comparison between this and the global financial crisis, but some of the numbers that we've seen in terms of the moves, the speed of the moves, it is a bit reminiscent of the sea change that we saw back then. So, I think that what we're going to see is we're going to see earnings numbers come down to reflect the reality of that change in growth trajectory that you mentioned earlier. That's a big change to go from 2.5% to 3% growth to go into 0% growth simply because of the tariff situation.

And the fact that you've got the Fed potentially sidelined because of the inflationary impact, I mean, the market is rapidly pricing in the idea that recession probabilities have jumped to maybe 50% or 60% from sub 20%, 10% to 20%, maybe when we came into the year. So, it's been a total sea change in the span of less than three months. And we've seen the market really kind of go to pieces in the last three days.

Again, hard to say that we should be committing money to risk assets today, but we probably are getting close to a place where you're probably going to feel good 12 months down the road from committing capital to the markets, but it's really hard on a day like today to step in on it. But 12 months hence, if you look at the data, when you get these spikes in the VIX above 36, which is two standard deviations on a closing basis, on a 12-month forward basis, you've been very well rewarded from committing capital to markets in these kinds of situations. So it's something to think about. Sometimes the hardest thing to do is the right thing to do and that's kind of where we're at right now.

[00:11:42] George: That's really, uh, important advice, Steve, that I think we just need to underscore that sometimes, as you said, the hard thing to do is the right thing to do, and we'll have to revisit that time and time again, I think probably in the next few weeks, because this is going to be a process. This is not an event, even though it feels like the initial moment was an event, and we've talked before that these things take time. And usually why the event kind of signals this or maybe kind of kicks this off, this does take time for resolution to actually occur.

You also mentioned though a little bit about the Fed being somewhat constrained and we talked briefly I think at the onset about today's payroll report and the job market actually looks pretty solid, at least at this moment, but it's probably the most irrelevant job report we're ever going to see in the sense that the market doesn't really seem to care about it and we're kind of focused probably not on last month's numbers but more focused on what happens next.

And with that being said, I think, Rajeev it's important to kind of get your perspectives on what the Fed might be thinking. They often are focused on inflation, and as I mentioned a few minutes ago, it seems like inflation is poised to move potentially meaningfully higher if these tariffs are sustained again. But how will the Fed process this? What's the market thinking the Fed's going to do? And more importantly, perhaps, what's your outlook also for the overall growth trajectory and how we think about rates going forward?

[00:12:59] Rajeev Sharma: Well, you know, George, I mean, the Fed and Fed Chair Powell have come out and said that, you know, whatever impact from these tariffs will be, quote unquote, transitory, I don't think the market is buying it.

The first thing we've seen is a continued flight to safety post this tariff announcement. The bond market is pricing for multiple rate cuts, along with the rise in inflation. So it's almost like the market is not really thinking about inflation, they're thinking about the growth of the economy, and they're really looking at the Fed to step in and start doing multiple rate cuts. And that's very bad for anyone who's on the sidelines here when they think about what the Fed's going to do. There are many people just about a month ago that thought the Fed is not going to anything this year, and now all of a sudden, you're talking about multiple rate cuts.

The markets are reacting to the U.S. talking itself into a recessionary scenario. Thursday's weak ISM services data did not help. We now have a healthy jobs report, although that was before the impact of tariffs. We now have a 10-year that has now fallen below 4%. And I think literally a few weeks ago, I don't think anybody would have thought that we would have a 10-year that's below 4%. Now if we hit 3.8%, that would be the lowest since we've seen since last October. We have a yield curve that's steepening. We've got 2s, 10s curve around 40 basis points. That's the steepest level we've seen since October 2021.

And other market expectations for Fed rate cuts by the end of the year have jumped to about four rate cuts. We were leaning to three rate cuts by market expectations before the tariff announcement. And traders pretty much expect that the first 25 basis point rate cut will happen at the June FOMC meeting. In fact, the market is now leaning towards four rate cuts by October. So that's a very aggressive move. Many people think that if the Fed steps in, maybe things will get better. But if the market's already anticipating four rate cuts by October, it's being priced in already.

And I think the resiliency of the market has come into question when you look at credit spreads. I've spoken about this over the past several months, that how resilient credit spreads have been in the face of all the noise that we've seen in the market. But investment grade spreads are wider by seven basis points this week. We're on 101 basis points over U.S. Treasuries for investor-grade spreads. High yield looks worse. The risk-off environment is not helping high yield. High yield is wider by 40 basis points on the week.

Spreads on the lowest quality corporate bonds, they spiked the most since the pandemic. And investors right now are thinking default outlooks and the rising risk of an economic slowdown are really starting to weigh on the market right now as far as credit spreads go. But if you look at where we have been in the past, similar situations where growth was coming into question, growth scares were coming into the question, we actually have a lot more room to widen to match some of the equity sell-off that we've seen.

And if you're thinking recession, then we have a lots more room to widen CCC-rated bonds have led the sell-offs, but still nowhere near recessionary levels. Spreads on double B and single B rated debt are the highest since 2023, but there is more widening for the riskiest segments of the market that we could anticipate. So in that environment, we have continued to advocate for high quality liquid exposures in our portfolios.

I also want to point out that credit default swaps, credit default swap indices are blowing up. We've got high grade and junk indices, both showing levels that we haven't seen since August, 2024. And it's a key measure of a perceived US credit risk. They've hit their worst levels since the past eight months. So the CDS index rises as fear climbs. And so U.S. bond investors are concerned that tariffs may lead to a global slowdown. And I think this is really weighing on the market. I think you're going to see a lot of corporate issuers step back in this environment and wait to decide whether to come with new deals or not. But a 10-year below 4% is something that was not anticipated just about a week ago.

[00:17:11] Brian: Great conversation today. I think it's important for our audience, given all the fast-moving information around tariffs of the economy and the markets, to get George your thoughts, closing remarks, and what are good reminders for investors and our audience these days in terms of times of turmoil like this from a portfolio perspective.

[00:17:28] George: Well, Brian, again, I would reiterate what Steve said earlier, which again is doing the hard thing is usually the right thing. And that sometimes being able to put capital to work when things really feel the worst. And I don't think we're quite at that point yet. Again, as Steve mentioned, some of the indicated for watching suggests that maybe it's getting close to doing that. And I think it's hard to do this in this environment. But I think the idea of really thinking about the purpose of your portfolio is a gear towards a long term investment objective. And if so, really kind of keep that long term horizon in mind.

And so we're not recommending any major changes. We've been really trying to advocate for the notion that being diversified in this year made a lot of sense. We've argued, I think, that since the beginning of this year, if not before, that being diversified with respect to country exposure, with respect a sector exposure, and certainly certain styles of the market and also certain securities makes the utmost sense. And that's really kind of one key takeaway that we should remind ourselves of what's happening this year. So I think it's important to really stay balanced, stay diversified, and at some point, it makes sense to be opportunistic. We have a lot of things we just don't know and the uncertainty is always the hardest part, but with uncertainty comes opportunity. And I think we should be able to look up to that as well.

[00:18:37] Brian: Well, thank you for the extended 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.

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