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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, September 27th, 2024. I'm Brian Pietrangelo, and welcome to the podcast. As we approach the end of the third quarter, it's always an opportunity for us to take a look at how the market is performing as well as various strategies, and we'll give you those updates here in the next couple of weeks for the third quarter. But it also brings the time of change as we move into the playoffs for the Major League baseball season. And congratulations right here to our own Cleveland Guardians in terms of their ability to make the playoffs, which they did and congratulations to them and all the other teams that will be paying in the postseason, otherwise known as the Fall Classic.
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 Mateyo, Chief Investment Officer, Rajeev Sharma, Head of Fixed Income, and Connor Cloetingh, Senior Equity Analyst.
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 news, we've got three quick updates for you beginning first with the weekly initial unemployment claims for the week ending September 21st, came in at 218,000. Which was very consistent with prior weeks and probably the last four weeks that we've gotten in terms of stability in the labor market.
And second, also yesterday the third and final estimate for gross domestic product for the second quarter of 2024 came out and was revised but didn't change the number. So the second quarter came in at 3.0% for the third estimate, the final estimate, which was the same as the previous or second estimate.
And even though some of the underlying numbers were changed, but in a very small way, the aggregate number came in at the same, at 3.0% for the quarter. Consumer spending continued to remain strong as part of the contributor to the overall GDP, as well as imports were on the decline, which was a negative subtraction.
Interestingly enough, even though it seems like a long time ago, the Bureau of Economic Analysis actually upgraded or revised upward the first quarter of 2024's GDP estimate from 1.4% to 1.6%. Again, we're seeing underlying strength in the economy, which was a little bit better than expected.
And as we turn to our third update, just came out this morning, from also the Bureau of Economic Analysis, in terms of overall consumer spending and personal consumption expenditures along with PCE inflation, so we'll start with the expenditures, which is the actual spending on a month-over-month basis. So we saw consumer spending did slow down a little bit from July at 0.5% to August of 0.2%.
So as we talk about going into the third quarter, we'll keep our eye on the overall level of consumer spending. However, the most important part of that print in terms of inflation was overall PCE inflation, which month-over-month came in at a little bit lower rate in August than from July. Both came in at 0.1% for overall PCE and 0.1% for PCE, excluding food and energy, which we typically call core inflation, down 2.2% in July.
However, if we look at the year-over-year numbers, we see a little bit different of a mixed result. So first in August, the year-over-year number for PCE overall went down from 2.5% in July to 2.2% in August, which is headed in the right direction. However, on the other side of the coin, when we look at PCE, excluding food and energy, for August year-over-year, the number actually went up from 2.6% in July to 2.7% in August. So going slightly in the wrong direction, we'll look at this as a potential year-over-year monthly anomaly with a base effect, but we'll continue to watch this as we go into the last few months of the year to see how that is trending relative to overall PCE inflation.
So let's turn to our panel starting with Rajeev and ask the question, what do you think these two data points specifically strong numbers in relative to GDP and overall a little bit of a mixed number, but pretty good in terms of overall inflation, what does this mean for the Fed as we go into the November meeting and the December meeting later in the year? Does it allow them to continue their policy of cutting rates or are they going to have to make some type of pivot, Rajeev?
Rajeev Sharma:
You're right, Brian, we got the GDP numbers, but that really didn't move the market too much. But today's personal income and spending data that we got was very important, and that's in the form of the August PCE numbers.
Today's PCE report is important not only because PCE data is the Fed's preferred measure of inflation, it also is the first inflation report that we've received since the Fed's jumbo rate cut that we saw earlier this month. The data showed that the headline rate for August fell to 2.2% on the year, while core PCE was in line at 2.7%. With the monthly core PCE numbers coming below estimates, the data did what it was supposed to do, and that is to validate the Fed's decision to start its rate cutting cycle with an aggressive 50 basis point rate cut.
The data keeps the Fed on track for future rate cuts because it shows that inflation continues to move towards the Fed's target of 2%. It also opens the door for another 50 basis points of rate cuts by the end of the year. The soft reading on core PCE inflation takes away some of the concern that the market had after the GDP report that perhaps inflation will start to creep back up into the market.
So with this report, you can see that consumer spending is likely to slow down even as income growth remains robust, with inflation numbers supporting a continued disinflationary trend, the Fed and the markets will now squarely focus on the upcoming jobs data and that will set the tone for future rate cuts by the Fed.
If we look at market probabilities right now are 50/50 odds for another 50 base points of rate cuts at the November FOMC meeting. But what's more important is that after today's PCE report, the market is anticipating another 75 base points of rate cuts by the Fed by the end of the year.
In my view, that is pretty aggressive. The Fed came out, they said possibly 50 basis points of rate cuts in their last FOMC meeting by the end of 2024. The market took that and actually went further and went for 75 basis points of probabilities now. And it's going to lead to continued disconnect between market and Fed expectations that adds volatility to the market.
If we look at the reaction of the yield curve, we see pronounced moves lower in the yields in the front end of the yield curve. The front end is most sensitive to Fed policy and since the last FOMC meeting, we have seen the front end yields move lower at a faster clip than longer maturities, such as the ten-year Treasury yield.
This has caused some steepening in the yield curve, a continued steepening that we've seen since the GDP report, and we've really been seeing about six sessions really of a continued steepening of the yield curve where we saw the front ends move lower at a faster clip than the longer end maturities of the yield curve.
If you look at the two-year Treasury yield, that's moving towards the recent low of 3.5%, but I want to point out the ten-year Treasury yield, which is starting to move lower now after that PCE report, and that's because the ten-year had been showing concerns that inflation could begin to rise.
Today's report puts that concern at ease and you see the immediate reaction on the ten-year Treasury yield, which has moved lower. If you really want to see what the market thinks about inflation, the state of the economy, just look at that ten-year Treasury yield, and if you start seeing it move lower, the market's not as concerned about the slowing of the economy, it's not as concerned about the state of inflation. The market seems pretty good about that as far as the latest PCE report, but if we start seeing that ten-year start to climb higher, that means the market concern that inflation's going to uptick, it's starting to set back into the market again.
So the market continues to deal with not only this data that we continue to see coming out, but also auctions that we've seen in the form of Treasury auctions. And we saw two very noteworthy auctions this week that was a five-year Treasury note, and the seven-year Treasury note. Investors demanded concessions on both of them and they got those concessions.
So investor sentiment right now in the market is buy on the dip, and we should see that more as we go forward. Every time we've seen some kind of pullback in yields, investors have stepped in and caused some support there, and we should see that continuing all the way up to the next jobs data that we see next week. But I really do feel that the market's very well contained right now. The market's looking at this that the Fed's doing the right thing, the Fed is on their path to continuing rate cuts, and we should anticipate that that should not slow down in any way unless we see some kind of data come out that shows that the Fed has made a policy error.
But so far so good. So the Fed should be very happy with the numbers that they're seeing in the market for inflation, and the Fed should really be squarely focused on jobs data.
George Mateyo:
Well, Rajeev, I was going to chime in for a second and before I kind of give my little spin on things, maybe you could help our readers and listeners understand the term concessions. You made the point that when people, or the US government really came to market, and I think the supply was pretty large, you could tell me probably the amount, but when you talk about concessions, what does that mean? Does that usually mean that the buyers actually demand more in terms of what they're willing to pay for or how do we think about that in terms of the overall bond market itself?
Rajeev Sharma:
That's a very good question, George. When you see the five-year for instance, we had $70 billion of five-year treasury notes coming in on auction, and we've already seen after the last FOMC meeting that yields have moved lower. So for investors to get excited about taking part in that five-year auction, they need to see concessions in the form of the yield should be higher than where the market's trading.
So when these auctions come at a level, those yields should be higher than what the market is currently trading at a five-year. So any kind of concession, they're not going to buy a treasury auction if it's going to be at the same level right before the auction. They need to see at least two or three basis points of upside with the five-year treasury note to take part in that auction. Otherwise, they're not going to do it, especially with the moves that we've seen with yields moving extremely lower in the last several months, we're going to see investors start to demand more to take part in these auctions.
They're going to want at least two to three basis points higher in yield than where the current five-year is trading and they're getting those auctions, they're getting those concessions. These deals are coming with at least two to three basis points above where a five-year and seven-year were trading this week.
George Mateyo:
Well, thanks for calling that out. I just wanted to mention that a little bit because we're kind of dealing with a situation where government debt in general is pretty high around the world right now, and that's one thing that we have to be cognizant of, I think to that could probably provide some challenges if we're not careful.
And I think at the same time, what you're seeing in the bottom market is reflective of that, Thankfully, I think, the full faith and credit of the US government is still alive and well, and that's really good to see. But the other situation that people are probably thinking about this week is China, and that's a good situation to remind people that when debts get to levels that are unsustainable and you look at that maybe relative to overall income in the economy, that can lead to some painful economic outcomes.
And we've seen that play out this week. And we've seen it play out for quite some time, frankly. But usually when debt is high, it eats into spending and hurts growth in other ways, and that usually either results in maybe some deflation because consumers are pulling back on their spending, or governments actually have to put more students to work and that could lead to inflation.
So it's a really tricky thing to figure out. And of course a debt problem is compounded by the fact that you don't really know exactly how much you need to reduce debt until you're really in it. So it is one of these things that you just don't know it's going to play out until you really get involved in it.
And China's economy, of course has been especially opaque over the past couple of years. Furthermore, I think China's also been in the situation where they've been reluctant to do a lot in the past couple years or so. Their market has been crawling around for the past couple of years at a low trend growth rate for them. And they've been focused on probably worrying about more hazards and people taking on too much debt.
So the government recently has been pretty low to try and do things. This past week however, that changed a little bit. I think it really caught the market by surprise. It caught me by surprise to be quite candid. And they did a lot, they put forth a number of different measures on the banking side where they cut interest rates across the board in a pretty notable way. They also lowered borrowing rates for mortgages and so forth. And I've even heard things that they're literally passing out cash to people on the street who are dealing with poverty. So they're really trying to get very aggressive here, which is I think a pretty big shift.
So it's one of these things I think that we've seen the overall market in China bounce, I think the stock market is up something like 10% this week. It's still down, I think roughly 25 or so percent from where it was a few years ago. So we're still in a long-term bear market in China, and we've been underweight emerging markets for quite some time, but this has got our attention.
And one thing that we're going to be talking about probably a lot in the weeks ahead is how do we think about emerging market position going forward? I do think it probably throws out, or maybe at least de-emphasizes the narrative that China is uninvestable. That was one thing that people were talking about the past couple years, and maybe this gets people to think about China again and thinking about diversification in terms of emerging markets and international markets too.
But I do think that the overall situation in China is not yet fixed, so we want to be clear about that. We don't think this is... maybe it's turned the corner a little bit, but they still have probably more work to do. So I think for me, and if I think of you Connor, and thinking about the equity market here back home, I'm sure there's probably some ripple effects that you're watching as well. What was your take about China's situation this week and what do you see in the US more specifically?
Connor Cloetingh:
Thanks, George. So with all the China stimulus news we saw this week, I think the initial equity market reaction was squarely focused on what companies, one, have exposure to China at a greater rate than the average US company, and two, the commodities that are consumed by China, given that it's the largest consumer of commodities and energy in the world. And so the initial market reaction was material stocks moved markedly higher, so industrial metals were the primary beneficiary of that move this week.
And then more across sectors, companies that may be selling to China more than their peers, we saw them tick up a little bit higher. So materials moving higher. It shows that investors believe that commodity prices may have bottomed and will move higher, but then I think to your point, it's what are the knock-on effects? If investors think earnings are going to move higher for materials companies, that means prices are moving higher for materials, which would go against this deflationary kind of cycle that we think we're moving into or had things. So those are what we saw from that equity part.
George Mateyo:
I guess other thing I would note that people need to pay attention to is the fact that the US market is still trading roughly around 21 or so times earnings, which by historical measures is still pretty pricey. Of course, we had periods of time in our history where it was much higher than that, but the average I think is probably close to 17 or 18 times. So we're a good bit above the long-term average.
China's stock market, you could tell me Connor, but I think it's turning around 10 times earnings or so. So it's about half that in terms of the valuation. And that's one thing that we could probably see that... I wouldn't see that gap close anytime soon, but it could narrow a little bit in the margin. So I guess if we think about where we are as we head into the last few weeks and months of the year, I think for us it's really important to really remain diversified, and we've talked about that many times, but it does get overlooked, especially when you see markets continue to melt up, as we've seen the past couple of weeks or so.
It only seems like it's a one-way direction higher, but I do think diversification will continue to play out. I do think we're probably due for probably a bit of some volatility coming back in the market. Maybe it's election driven, maybe it's something else, but it's been a pretty calm market for the past couple months as well.
So in our perspective, I think it's really important to emphasize quality, emphasize really being selective in terms of where you put your capital to work. We also do think that cash is probably going to be a little less attractive in class going forward, and that's why Rajeev and his team focus on high quality fixed income as well. That's really probably a good substitute probably for some of these excess cash reserves once yields start to come down a little bit.
Brian Pietrangelo:
And thanks for the conversation today, George, Rajeev, and Connor. 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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