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, January 31st, 2025. I'm Brian Pietrangelo and welcome to the podcast. We've got a lot to share with you this morning on our podcast today. But before we begin, we would certainly like to take a pause and acknowledge the horrific airline tragedy in DC this week, and our hearts and prayers grow out to all of those affected and the families, of course.
With that, I would like to introduce our panel of investing experts here to share their insights on this week's market activity and more. George Mateo, chief investment officer, Steve Hoedt, head of equities, Rajeev Sharma, head of fixed income, and Cindy Honcharenko, director of fixed income portfolio management. 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. 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 three pieces of information for you on the market and two pieces of information regarding the economic releases for the week. In terms of the three pieces of information on market activity, we're going to dive in with our podcast panel, especially Steve, to talk about the market volatility this week in a reaction to the DeepSeek announcement regarding AI. We'll also talk to Steve about some tech earnings this week that were somewhat drivers of the market in general. Third, we'll also talk about the federal open market committee meeting and their press conference on Wednesday of this week.
For the two pieces of economic data just yesterday we'll start with the gross domestic product for the United States came out with its advanced estimate or first estimate from the Bureau of Economic Analysis for the fourth quarter of 2024. The annualized rate for the quarter came in at 2.3% for the fourth quarter, which was lower than the third quarter, which was at 3.1%. Overall, consumer spending continued to remain strong within the quarter. Government spending helped a little bit. Imports and exports were a wash, and the overall private investment and inventories was somewhat of a slight drag. Ultimately, overall decent consumer spending continued to drive overall real GDP in the fourth quarter.
Second, just this morning earlier from also the Bureau of Economic Analysis, the Personal Consumption Expenditures Measure of Inflation, which is again the Fed's preferred measure, PCE inflation, excluding food and energy, came in year-over-year for the month of December at a 2.8% rate, which is the third consecutive month at 2.8%, and it has not declined for more than six months. We'll definitely talk about what that inflation read might mean for future Fed decisions and fed policy. Leading to that, we will start with our panel today with Cindy to give us a recap on Wednesday's Federal Open Market Committee meeting. Cindy?
Cindy Honcharenko:
The committee maintained the current federal funds rate target range at four and a quarter or 4.5%. The rate paid on bank reserve balances also stayed unchanged at 4.40% and no change to the balance sheet runoff 25 billion per month for treasuries and 35 billion per month for mortgages still stands. The description of the labor market and the inflation environment and the policy statement were edited. At first glance, the shift looked somewhat hawkish, but they were very small shifts, and when viewed in the context of keeping rates steady. Paul and his colleagues had clearly flagged their intent to keep rates steady during the intermeeting period and the revisions to the December SEP show a greater concern about stalling inflation, so it logically flows that they would drop a reference to making more progress. The press peppered Powell with questions that either he couldn't or wouldn't answer regarding hypotheticals on tariff shifts in fiscal policy or his relationship and interaction with President Trump.
The most significant comments were those in response to a question about whether discussions had begun about the plan for ending QT. Powell responded with a comment that data are consistent with abundant reserves. They're monitoring the situation based on a host of metrics, and they will make adjustments when it becomes clear that they're necessary. Previously, the expectation was that QT would end in March, but that view does not look particularly likely now at this point. Now, these expectations have been pushed back to June.
Finally, Powell was also asked about whether a March cut was on the table and he responded that they were in no hurry. Going forward, investors I think need to anticipate that this hold on rates could be for an extended period. The length of the committee's policy hold may be correlated by how long tariff uncertainty exists. This could take several months, but from my perspective, the direction of travel would be set by the details of tariff policy. As we note from yesterday, it now appears that the administration will be imposing tariffs on a larger scale. We could eventually see a path to rate hikes because of this. George, Rajeev, I'd like to know your takeaways from the FOMC on Wednesday.
George Mateyo:
Well, I don't think they did a whole lot, and that's probably by design. I don't think they wanted to wait too far deep into the waters of policymaking and let the other end of whatever it is, Pennsylvania Avenue, not quite anyway, the other end of Washington to try and figure out what happens next, I think. As you mentioned, this weekend will be an interesting weekend. I think, Cindy, with respect to tariffs, and frankly, there's a lot of wild cards that go into that, right? We don't know how other countries are going to respond. We don't know what other companies might do in response to that, and we also don't know how long they might last or are they broadly applied? Are they focused on certain goods? There's just a lot of unknowns, frankly, a lot of known unknowns, I guess, and a lot of unknown unknowns too.
I think the market's going to have to deal with some uncertainty for a while now, and the Fed probably is beholden to that, too. I think they're all frozen place for a little bit, thankfully. I think the overall economic data continues to be pretty good as we see it though. The overall backdrop is in pretty good shape as we enter this period of uncertainty, and sometimes when you have that environment, it's probably best not to do much of anything major to your portfolio, because I think you [inaudible 00:06:53] just focused on the news too much. I guess. Rajeev, we've all been talking about the Treasury auction market in terms of the overall demand for Treasuries. Have you seen anything that's changed in that space?
Rajeev Sharma:
Well, I really think that in rates moving higher, George, you actually saw a little bit of a fear in the market that rates could continue to go towards say 5% on the tenure, and that gave investors a pause. When the auctions were coming out, investors are demanding higher yields to participate in those auctions, so they weren't really doing very well. Then yields started moving lower, and I think now the auction market looks like it get more traction because investors are feeling that we're further away from 5% than we were just a few weeks ago, even though we're around four and a half percent on the tenure. But I think that the feeling in the market right now is that yields could go lower. Like Cindy said, we did not get that rate cut and no one expected the rate cut this month, but with the statement removing language about making progress towards the Fed's 2% inflation goal, that was enough to make this a hawkish statement by the Fed, in my opinion.
Fed chair Powell tried to mask that by saying that we're doing a little language cleanup, but I don't think the market really believed that. The knee-jerk reaction by the market after the FOMC meeting was that yields moved higher and the path of future rate cuts now comes into question again. We have a Fed that's always been that they're data-dependent, market expectations are data-dependent and inflation seems to be front and center. The next Fed meeting we have is now going to be in March, so it does give the market a little bit of a breather, and it gives us some time to get more data points. I think that the Fed's preferred measure of an underlying inflation that came out today, the Core Personal Consumption Index, it remained pretty muted in December. Again, further rate of cut expectations move to about two rate cuts this year.
But there was, before the Fed meeting, I think the market was really anticipating a one in third chance the Fed would cut March. That's pretty much off the table right now. The Treasury market is still pricing the expectations that Fed rate cuts will happen in June, but I really don't see anything in the data right now that suggests that the Fed would be in any hurry to cut rates. Your point towards auctions, when these auctions come out, I think the market is really trying to figure out whether rates are going to go lower from where they are now or whether they're going to go higher from where they're now. There's been a lot of expectations to extend, duration, participate in 10 year auctions, 20 year auctions, 30 year auctions. But I think a lot of investors right now want to stay short or at least neutral towards duration.
We still subscribe to the fact that the Fed is in no hurry to cut rates. It's likely to be a second half of the year rate cut story if it even comes through. But I really think that the GDP report that came out, it impacted Fed fund futures. It cast down on whether we get any rate cuts at all for 2025, and as Cindy mentioned, the tariffs in Canada and Mexico, that will definitely throw some fear of inflation back into play. With that fear, you can see the rate cut expectations start to diminish.
George Mateyo:
What was really interesting I think this week with respect to the Fed was the fact that the news itself was buried beneath the crease as they call it, right? If you open up the newspaper, there's a top story of the day and then the bottom.
Stephen Hoedt:
What's the newspaper, George?
George Mateyo:
What's the newspaper, Steve? Well, it's this whole thing that once in a while we used to find our news from as opposed to our phone. But that's a good question and we'll talk about that. We'll talk about disruption and innovation in a second because I think that's a good segue, Steve. I'm sure you didn't mean it that way, but it's a good segue.
Anyway, I think it was interesting to see that the Fed news was on most, I guess, news feeds, we'll say Steve, further down the page or further down on your phone, depending on what you're looking at to get your news. The Fed, there's a lot of headlines regarding the tech sector this week. This time last week, we were starting to hear something about this thing called DeepSeek, and then it really morphed over the weekend.
It really took on a life its own. Again, to Steve, and I'll kick it over to you for a second, we have this moment in artificial intelligence where there's a lot of innovation happening, [inaudible 00:11:08] disruption. Maybe we can just talk about that and what you saw this week unfold with respect to what happened in technology.
Stephen Hoedt:
Yeah, well, just to look at the market last Friday, the close on the S&P 500 was 6,101, and today I stare at my Bloomberg screen at 10:15 in the morning as we're recording this. The S&P 500 is at 6,107. You would think-
George Mateyo:
Progress.
Stephen Hoedt:
Yeah, you would think that nothing happened this week, right? When we came in on Monday morning with this DeepSeek News over the weekend, it was total panic in the tech space. We saw NVIDIA, which is arguably the most important stock to the market, not necessarily from a market cap perspective, but if you look at the percentage of returns that has contributed to the S&P 500 over the last couple of years, it is a significant chunk of the S&P 500's total returns. That stock was down 17% on Monday, so we had a huge gap down, but literally every day the rest of the week we've climbed higher.
To the point that on a chart basis, you would be hard-pressed to think that anything happened. I find it very interesting that the market has been so resilient in the face of this news, which on the face of it on Monday morning caused people to start the process of reevaluating whether or not US technology shares really deserve the premium that they've been trading at in the market if a small startup in China can do something that the quote, unquote, hyperscalers have been trying to do and spending literally tens of billions of dollars to do so, right? I think we got some information as the week progressed that said maybe the things weren't as much as they seem on the face of it from the DeepSeek news, I know the US government's investigating whether they got NVIDIA chips through Singapore, it looks like they were actually running the high-end chips and they got transshipped into China through third parties using shell companies and other stuff.
That's fresh news this morning. I would tell you that when you look at the news that came out of Microsoft and Meta after the close on Wednesday, I think it was incredibly important for them to basically say all systems go on their planned spend on AI. If they had come out and said... For example, Meta had said 60 to 65 billion prior to this, if they had said, "Okay, we're going to reevaluate our spend based on this news," I think it would've been game over for the AI thematic in the market. I think people would've been thinking that there was something really big happening in terms of a sea change. It doesn't look that way today. I think that we definitely have seen change in terms of maybe a wake-up call for the tech companies and maybe also a wake-up call for tech investors to be a little bit more discerning about what they're paying for.
To be honest, anytime that you've got a dominant narrative in the market and there's a premium valuation assigned to that narrative, any change in that narrative can result in a massive move in price. I think that's what we saw on Monday. It wouldn't surprise me that over time we continue to see this because as you get innovation and news dribbling into the market, whether it's from China, Europe, God knows where, it's going to impact things. Because again, when you have a dominant narrative theme and a premium ascribed to that, changes to that narrative have larger impacts than what people might expect.
George Mateyo:
Yeah, I think we're all, on this call anyway, old enough to recall what happened the last time we saw this level of excitement around technology and the infrastructure build that went with it. I think one thing that you're referencing, Steve, is important for people to recognize is that when you have a new technology, some type of breakthrough innovation, usually companies come to the market, they seize that opportunity or they try to, anyway, capital flies in the market pretty quickly. Then lo and behold, the investor communities you pointed out, gets wind of that and ultimately they bid up valuations to the point of maybe a bubble. I don't think we're in a bubble right now, but I think that the conditions are a little bit ripe for one, if we're not careful.
But economically speaking, or fundamentally speaking, we saw the overall notion that when you have this massive build-out infrastructure, usually that leads to malinvestment, meaning people are spending money on things that they really aren't going to get a return on profit back. We have to be aware of that. I think it is important note that some of these big tech companies are still spending pretty aggressively, but we have to be mindful that they might actually see, we haven't seen the big killer app yet either. We haven't really seen what people use AI for. I think we have to be vigilant about that as well, don't you think?
Stephen Hoedt:
That's the one thing that concerns me the most is that we're 18 months into this now, maybe even a little more than that, and we have yet to see the true killer app emerge. I can't believe that the killer app is a chatbot on your phone, right? The killer app has to be an application of that. I think part of what we saw in terms of the market discerning winners and losers from this new information was the performance of software stocks relative to semiconductors, right? Semiconductors all along this have been viewed as the key enabler. NVIDIA has been the poster child for it, but there've been a lot of other semiconductor stocks that have also benefited, Broadcom, Marvell technologies, these are other names in the market. But I would tell you, if you look at what happened on Monday and what's persisted this week is you've seen a small and mid-cap software names outperforming the market on a relative basis.
Essentially, what that's telling you is that if we were in a world before where these hyperscalers had to spend tens of billions of dollars be able to put AI into their products, if you get a massive decrease in the amount of money that's necessary to put an AI product into the market or an AI-enabled product, it opens the door for massive amounts of innovation by much smaller companies. When we think about what that means, you've got all kinds of small and mid-cap software companies that could embed things in here and be able to sell to their markets and have their clients have enhanced productivity from this, theoretically. Again, we don't know what the killer app is. I doubt that it's a chatbot app, but at some point the innovation seems like it's going to continue and we will get to a point where we see something that's going to enhance productivity for the end users, the adopters, as we call them, right, George?
George Mateyo:
Yeah, that's right, Steve. I think if people want to take a look at the list of sectors that we think are probably more adopters versus enablers, we're happy to send them along because I do think the market, as you pointed out, is starting to get bifurcated. Maybe investors are becoming a bit more discerning rather than just owning a handful of stocks on one sector. I think that's the key message here. I think we have to acknowledge that people are going to be more discerning going forward. I think, again, we are in this transition at some point from the enablement phase of artificial intelligence to the adoption phase, and that usually takes a while, but once it takes hold, it is very broad-based and many sectors of the economy should benefit from that over a long period of time. The other thing I think we've been pointing out over this discussion on AI for the last, I call it 18 months or so, is that I think in some ways people overestimate the benefits of a new technology in the short term, but they underestimate the benefits on the long term.
That's a quote, I think, that that's loosely attributed to Bill Gates of the co-founder of Microsoft, but I think it's pretty accurate. I think that's been played out over time where I think people get overexcited in the near term and they recognize maybe the potential too early, but then they underestimate the long-term benefit over the long run. Again, I think for us, as investors need to recognize that we think we are going through this period, we talked about at the beginning of this call, that maybe more uncertainty, not less is going to be the narrative going forward. With that comes this notion of maybe higher volatility. In our view, we think it's important to really revisit exposures, look at single stock concentration risks. Maybe you have a certain stock in your portfolio that might be an outside position.
You look at certain sector performance. Again, there, too, over the last few years, there's been a bit of wide dispersion amongst growth sectors versus value sectors. Again, we're not trying to disavow ourselves and try to say you don't want to own technology, but at some point you want to rebalance your portfolio potentially at the margin. The same thing overall. We've been overweight US markets relative to the international markets, and I think at some point maybe that reverts a little bit, but again, we want to be mindful of how we position our portfolios there, too. But that said, it's just important to really look at your exposure right now as you think about this transition that we're starting to undergo right now.
Brian Pietrangelo:
Well, thanks for the conversation today, George, Rajeev, Steve and Cindy, 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. Reach out to your relationship manager, portfolio strategist or financial advisor for more information, and we'll catch up within 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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