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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 understand the mysteries of the markets and investing. Today is Friday, February 9th, 2024. I'm Brian Pietrangelo and welcome to the podcast. With 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. 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 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 economic and market news the economic calendar was extremely light in terms of releases, so we've only got two data points to share with you today. The first being in the unemployment claims arena. We look at initial unemployment claims came in at 218,000 for the prior week. That is down from the week before that, and ultimately is showing that the jobs market continues to be resilient. On the other side of the equation, ongoing or continuing unemployment claims remain steady at 1.8 million. Again, showing us the same message that the job market continues to be resilient in spite of layoffs that we're seeing in various sectors and various industries.
And secondly, in terms of information provided by the Institute for Supply Management in terms of their purchasing manager's indices, we see that economic activity in the manufacturing sector has contracted in January and has contracted for the 15th consecutive month. On the other side of that coin, we look at the services sector where economic activity has expanded in January for the 13th consecutive months, and other than one blip, it has grown in 43 out of the past 44 months, with the only contraction being in December of 2022. That again is showing us that coming out of the COVID lockdown, the services economy has continued to expand. In addition, we've got a significant amount of economic releases in terms of earnings, so we will turn to Steve to get that update from a lot of companies who have been reporting for the last two weeks to get his take on what's happening in the first part of the year on earnings. Steve?
Steve Hoedt:
Well, the market has had yet another interesting week as we've continued to go through earnings yesterday. Intraday, we got above 5,000 for the first time ever, and today it looks like as of right now, we're probably going to be on track to close above 5,000 for the first time ever. So the market continues to power ahead. I think I saw a number a couple of days ago that now it's 14, we're on track to make it 14 out of the last 15 weeks in a row that the market has been higher, which is a streak that is pretty much unprecedented. You've got to go back to the early 1970s to find a streak where the market had this much consistency to the upside without having any kind of pause. So clearly the animal spirits are in control. Now the question that we are starting to ask ourselves though is how much further can it go?
And I think when you look at the performance of the Magnificent Seven, while the Magnificent Seven have done pretty good, or whether you call them the Super Six or the Fab Five, whatever you want to call them, the mega cap tech names have in general, had a pretty good earning season, which has helped the market power higher. But what concerns me is if you go back and you look at something like the equal weighted S&P 500, the equal weighted S&P 500 has not powered higher and is fact at the same exact place it was at the beginning of the month of December.
So the broad market has effectively marked time going sideways for the last two months while the mega cap tech names have ripped off to the upside. So we really want to start to see this rally broaden out. And while I am loath to say that I'm sitting here just looking for green shoots in the rest of the market, I will say that the performance this week should give the bulls a little bit more encouragement because we've started to see the rally broaden out into consumer names, into industrials names and into healthcare over the course of the back half of this week as the market moved higher.
So if we can start to see this continue over the next week or two as we wrap up earnings season and head into the, I guess it would be we would say probably Fed watching season for the next couple of months, I think that we probably are in a pretty good place. Earnings numbers, just to summarize, I know I talk about this during earnings season most of the time, the numbers have been good enough. They've beaten estimates by almost 7% in aggregate. 71% of companies have top projections. That's about in line for where companies are typically reporting in terms of beat rate. The numbers are game, so everybody knows that beat rates come in high.
The thing for me is always to watch the market reaction and the reaction to the upside had been muted through the early part of earnings season. But now that we've got the mega caps through, and we've had some of these better reactions to industrials, healthcare and consumer this week, now, if you beat on both revenue and EPS, you're outperforming the market by 1.8%. The average outperformance is 1.7. So we've seen a little bit of a pickup there. We had been outperforming by less than the average until this week.
And then on the downside you're still getting gobsmacked. So if you miss on both numbers, you're down 5.2% versus an average of 3.1. So basically we've started to see a bigger spread between winners and losers during the earning season, and quite honestly, that's actually what we want to see. You want to see winners rewarded and you want to see the losers get punished. That's a sign of a healthy market. When both when you have winners underperforming relative to average and losers getting punished, that's the sign of a market that's not doing very well. So the fact that we're in a configuration that's very supportive here, I think it bodes well as we head into the later part of the spring.
Brian Pietrangelo:
So Steve, what do you think it means in terms of the Magnificent seven and the 493 closing the gap? Is it the Magnificent Seven need to slow down or is there some catalyst for the broader market to be able to move forward?
Steve Hoedt:
So valuation is your big one, and I am dubious on the Magnificent Seven slowing down. Maybe one or two of them will. Obviously Tesla's had some issues here lately, and there's a lot of talk in the market about what the verdict is on electric vehicles in general, but I would tell you that when you look over the last 10 years, these companies have compounded earnings between 20 and 25% per year. There's a reason why they're so big. They have had numbers that justify the contribution, and unlike the bubble period back in the late nineties and early two thousands, when tech got to 25% of the S&P 500, but was only 6% of earnings, if you aggregate these mega caps together with tech today, they're between 30 and 35% of the S&P 500, but they're generating fully 25% percent of the indexes earnings.
So we don't have a complete disconnect here whatsoever in terms of valuation, even though people may want to try to make it be one, there isn't one. So I feel like we are extended in terms of the market on a forward valuation basis, you're over 20 and a half times other than the two bubble periods, meaning the COVID period and then the period in the 2000s, you typically don't see forward earnings numbers get much above 20 unless there's something really strange going on. So I feel like the market is a bit frothy from evaluation perspective, and I would like to see the names underneath perform better. It doesn't mean those Mag Seven names need to correct, they can just go sideways and mark time and allow themselves to grow into the performance that they've had over the last couple of years.
But when I sit here today, Brian and I look at a name like NVIDIA, which is already up 40% on the year to date, I mean, to me, there's a lot of good news baked into stocks when they go up 40% in a month.
Brian Pietrangelo:
Makes sense. Rajeev, what are you seeing in the bond market?
Rajeev Sharma:
So Brian, we did hear from Fed officials this week, so there was a lot of Fed speak, and there are basically two key takeaways that I could gather from what they said. Most of them are taking a very measured approach towards this January employment report. They're viewing it as a further reason to be methodical in their approach. There has been a lot to do with this luxury that the Fed has right now to take its time when it comes to rate cuts, and I think that affords them that time and I think they don't want to make a policy error, so they're going to take their time. We all know the market's looking for these rate cuts. We all know that the expectations are the rate cuts are going to come. The Fed has signaled that they will be cutting rates this year, but it's just a question of timing.
One of the other key takeaways there was that there are Fed members that care deeply on the employment side, and that's one of the sides of the Fed's dual mandate. So you would have to see a real slowdown in the labor market to have Fed speak start to reflect a dovish outlook. We are not seeing that right now. Labor markets are strong and you're not hearing from those Fed members who are labeled as dovish. The hawkish members of the Fed that are speaking, they worry more about inflation and whether policy is restrictive enough. So the market did shift its focus on commercial real estate this week as well. And when commercial real estate pops up and you start thinking about banks and their exposure to commercial real estate, the anticipation of early rate cuts started to gather some steam again, however, we had Richmond Fed's Barkin come out.
He gave an interview and he pretty much put an end to the speculation that there would be a rate cut as soon as March. And that's what the market has started to price, that maybe this emphasis on commercial real estate, the impact on banks, maybe that would cause the Fed to blink, maybe that would cause the Fed to move earlier than expected. But Barkin said that unless the economy turns south, the Fed will not be jumping in with rate cuts. Commercial real estate, according to Barkin, is something that is a known issue by the Fed, and they expect the banking system to be resilient and have enough capital to weather any kind of risk there.
So the market had been pricing, we started the year off, the market was pricing seven rate cuts for the year. It's come down to five rate cuts for the year as far as the market expectations go. The Fed continues to signal three rate cuts this year. And that disconnect that we've talked about several times on these calls is that that's the disconnect that adds volatility in the market. So every piece of data is scrutinized, every economic piece of data is scrutinized. Every Fed member that's speaking is being scrutinized for any kind of cues that maybe Fed rate cuts would come earlier than expected, or what's the impact or how many rate cuts we can expect this year.
Now when you see real rates where they are right now within positive territory, that gives a lot of market participants expectations that the Fed will try to bring that down. My personal opinion is that I do not think that the Fed is in any rush really right now to cut rates sooner than later. I do think it's going to be a second half of the year event, but I do think that the Fed has this luxury right now to look at more pieces of data, and I think they'll continue to do that.
Now, we also had increase in treasury supply this week. We had treasury auctions this week. In particular, the ten-year and the third-year auctions were very well received by the market, but we continue to see yields higher this year, and it's not only due to the increased supply that we're seeing in the market, it's also due to the pushback on the notion that we will see rate cuts earlier than expected. So I think that all of that combines to keep us elevated in rates for a little longer than many would like. But these are levels right now where you're getting really good rates to invest right now in active management. If you look at credit, credit spreads are doing extremely well right now. They're well-behaved, they're not screaming any signs of any economic downturn. On top of that, you have a lot of supply and corporate bonds that are coming to market, and you're seeing a lot of interest in those corporate bonds because you're seeing coupons right now that you haven't seen for blue chip companies for a very long time. And I think that continues.
So again, we advocate for corporate bonds over U.S treasuries in this environment, and we do think there's a lot of value that continues to be out there in the form of coupons and these higher rates that we see right now.
Brian Pietrangelo:
So I know it's unfair to do this to you, but I'm going to put you on the spot, and I know your answer will be, it'll be based on a lot of the data that comes out in the next three months, but where do you see the potential for the first cut, if there is one? Because we know it's not March, but then we've got three in a row, May, June and July. Just what your speculation right now, Rajeev?
Rajeev Sharma:
If I put on my speculation hat, Brian, I would say that the first rate cut would come in May. That gives the Fed enough time to see more data. I think right now the probabilities of a May rate cut are elevated. I think that it's justifiably so, definitely by June, but I would notion it would be May.
Brian Pietrangelo:
Great. Thank you for that. And Steve, let's turn back to you just for a couple of quick observations to end the podcast. What are you seeing in terms of commodity prices and maybe what do you think about some other things happening in the market, whether it's housing or this new streaming agreement that we're hearing about? What are your thoughts in general?
Steve Hoedt:
Yeah, so I'll just say on the commodities situation, look, commodity prices have been firming here lately, so it'll be interesting to see if we do start to have the Chinese economy start to reflate a little bit as we move through the middle and back end of the year. If you look at their PPI and CPI data, they've actually been exporting deflation to the rest of the world over the last six plus months or so, and they really don't want to let deflation get embedded into their economy. It would be a very serious situation for them. So they're going to take action to try to reflate, and my belief is that that's going to feed through to commodity prices globally. Also, there's been a number of reports here lately about crude oil supplies being tighter than what people have expected at this point. So I think that you're looking at the potential to see commodity prices firm as we move through the middle and end of the back end of the year, and possibly significantly so. So it'd be something to watch for sure, especially with the Fed attuned to inflation and things like that.
The streaming agreement, just to finish on something that's different and interesting, it really seems to me that sports has been the reason why people have maintained having cable subscriptions, because you can't watch live sports without one, it seems like. And the streaming situation to access sports, you've had to have a YouTube TV or Hulu or some other kind of thing. And even then it's not been perfect because not all of the sports services are on every one of these platforms. It's been kind of a hodgepodge. People had to buy three or four different streaming packages and the fact that the Disney/ESPN, Fox and Time Warner or Warner Brothers, seem to be getting together to put together a sports package with all of the stuff from all of those places all in the same thing, it could really be a game changer in the whole streaming situation. Because now instead of having to buy three or four or five different services to watch the stuff you want, you buy one or two of those and then a sports package and you've got your solution.
So I never thought that you would see these companies work together. I think it was a huge piece of news this week that could be impactful. And impactful for investors too, because frankly, when you look at the stock price reaction, you saw the stock price reaction that Disney had. Disney didn't react to the earnings number. They reacted to the fact that there's potential monetization of the ESPN streaming and the stock reacted really positively to it. So I think it's going to be fascinating to watch it play out, and I look forward to being able to get rid of three streaming services and just buy that one.
Brian Pietrangelo:
Yeah, it's funny, how's an evolution of an industry all the way back a generation ago when there were just three or five channels and now we've got it coming back into the fold where you get the ones that you want. So that's funny.
Steve Hoedt:
Rajeev how many services are you going to have to buy to watch the Philadelphia teams in New York if this goes through? That's the question, right?
Rajeev Sharma:
There's already, I feel like I have too many.
Brian Pietrangelo:
Well, thanks for the insights today during our conversation, Steve and Rajeev. We certainly appreciate it. 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 4:
The Key Wealth Matters podcast is produced by the Key Wealth Institute. The Key Wealth Institute is comprised of financial professionals representing key entities including key private banks, key bank institutional advisors, key private client, and key investment services. Any opinions, projections or recommendations contained herein are subject to change without notice and are not intended as individual investment advice. This material is presented for informational purposes only and should not be construed as individual tax or financial advice. Bank and trust products are provided by Key Bank National Association, a member of FDIC, an equal housing lender. Key Private Bank and Key Bank institutional advisors are part of Key Bank. Investment products. Brokerage and investment advisory services are offered through key investment services, LLC or KIS, a member of FINRA, SIPC and SEC Registered Investment Advisor.
Insurance products are offered through Key Corp Insurance Agency, USA, Incorporated, or KIA. KIS and KIA are affiliated with Key bank. Investments in insurance products are not FDIC insured. Not being guaranteed may lose value, not in a deposit, not insured by any federal or state government agency. Key Bank and its affiliates do not provide tax or legal advice. Individuals should consult their personal tax advisor before making any tax-related investment decision. This content is copyrighted by Key Corp 2023.