Key Private Bank Investment Brief

Fed cuts policy rate by 25bps. Future direction of policy adjustments still uncertain.
 

Key Takeaways:

• The Federal Open Market Committee (“FOMC” or “The Fed”) reduced the benchmark federal funds rate by 0.25%, setting the new target range at 4.50% to 4.75%.
• There were no dissents.
• Risks to achieving the Committee’s employment and inflation goals are roughly in balance.
• Labor market conditions were characterized as “generally eased,” adjusted from “job gains slowing” from the prior statement.
• The Fed’s assessment is that “inflation has moved much closer to our 2.0% longer-run goal, but core inflation remains somewhat elevated.”

The Federal Reserve’s Open Market Committee voted to cut interest rates for the second time in this easing cycle, and by 0.25% at today’s meeting, setting the benchmark federal funds rate target range at 4.50% to 4.75%. Today’s decision was unanimous.

The pace of balance sheet runoff was unchanged at $25 billion per month for Treasuries and $35 billion per month for Mortgage-backed Securities (MBS).

The language in the policy statement was little changed from September. The Committee made some changes to their assessment of the labor market and on their progress toward their inflation goal – possibly an attempt to shift the focus away from individual data points and more towards broader changes in the balance of risks as the driving force in their policy decisions.

Chair Powell’s press conference started once again with a commitment to resume progress towards the inflation target. The press began with questions about the details of September’s Summary of Economic Projections (SEP) dot plot, and Powell responded that “nothing in the SEP suggests the FOMC is in a rush” [with respect to future rate cuts]. When asked about the possibility of any sort of move in December, he flat out refused to provide a direct answer. He said he would “not rule out or rule in a December rate cut at this point.”

At the onset of the Q&A, Powell was asked about the outcome of the election and whether it has any impact on the Committee’s near-term policy outlook. As expected, Powell said that the Fed does not guess, speculate, or assume anything about fiscal policy until it becomes law.

On the employment front, labor market conditions were characterized in the statement as “generally eased” as opposed to “job gains slowing” from the September statement. Reading the tea leaves, the language simply communicates that the labor market has established a slower pace as a theme, but not yet to a troubling point as it pertains to the Fed’s dual mandate.

The bottom line is that the Committee continued to cut rates from a policy rate level that it considers highly restrictive. Inflation is lower than it was at the start of the year, and even if it has not fallen since the September meeting, it is still low enough to remove some restriction. Future rate cuts are not baked in the cake, but they are not completely missing from the recipe either. As a result, interest rates may be rangebound in the short-term, unless and until the labor market conditions significantly deteriorate.

Key Takeaways:

The election is finally here.

The presidential election is coming down to the wire. Harris has regained ground in some betting markets, and according to Predictit.org, as of 11/3/24 at 5:00pm ET, her odds of a victory have increased; whereas according to Polymarket, Trump’s odds are slightly higher. In both cases, the election is simply too close to call.

Key Wealth advises interpreting or relying on betting markets carefully as they are prone to considerable volatility, are not official polling results, and do not represent any type of endorsement or prediction by Key Wealth, Key Bank or any other affiliates.

Presidential election polls tell a similar story and foreshadow a very close election. Senate races are leaning Republican, while the House is a toss-up.

It is too early to determine the effect of the election on portfolio construction. A candidate’s campaign promises are not always implemented, and certain sectors may benefit depending on the winner. Both candidates’ proposed policies stand to boost growth, inflation, and federal debt.

Elections hardly ever cause recessions. Credit spreads are more reliable precursors to a recession than stock market volatility. Credit spreads have been very well-behaved recently, as they were during the 2016 and 2020 election cycles.

Economic momentum continues despite data distortions due to weather and strikes.

In recent months, the overall story in the labor market has been one of moderation, with payroll growth slowing gradually. Last Friday, reports indicated October nonfarm payroll growth of just 12,000 jobs versus expectations of more than 100,000. This data likely contains significant distortions due to weather and strikes, making it non-representative of the state of the underlying labor market.

On a positive note, the unemployment rate remains relatively low at 4.1% despite a slowly weakening labor market. Wage growth remains solid, benefiting the consumer. Overall, the US consumer is still in good shape.

Last Wednesday, the Bureau of Economic Analysis (BEA) reported that US real GDP grew by 2.8% in the third quarter of 2024. Personal consumption expenditures (i.e., consumer spending) accounted for the lion’s share of growth (2.46% of 2.80% total).

Consumer confidence shows an interesting split according to recent survey data. Consumers’ confidence in the stock market recently reached its highest level in 37 years of history, according to Bianco Research with data from the Conference Board. On the other hand, consumers’ confidence in the economy is still below pre-pandemic levels.

Bottom Line:

Key Wealth did an analysis of S&P 500 returns in the one year after presidential elections with data back to 1960. In the one year after each presidential election from 1960 – 2020, the average S&P 500 return was 13.2%, and the median return was 12.6%. Patient investors have generally been rewarded.

Both stocks and bonds may be range-bound over the near term, as much good news appears priced in at these levels. Recession risks have likely fallen with the Fed's recent 0.50% interest rate cut, which should support stocks over an intermediate to long-term time horizon.

Remain Neutral to Risk and emphasize Quality investments. Employ small tactical tilts to areas that carry less-demanding valuations. Use New Tools, such as alternatives and real assets, where appropriate. Don’t let your politics undermine your financial goals.

Equity Takeaways:

Stocks were mixed in early Monday trading. The S&P 500 was essentially flat at 5731, while small caps rose approximately 0.3%. International markets were generally higher.

Third quarter 2024 earnings season has been just okay. The average earnings beat versus analyst estimates has been a meager 0.3%, versus the average beat of 1.0%, according to data calculated by FactSet. On the positive side, earnings growth has been broadening across sectors – it is not just the technology sector leading the way this quarter.

The S&P 500 has been in a bit of a holding pattern in front of the election and has been consolidating near current levels. Stock market volatility (as measured by the VIX) has increased in the past few weeks, as well as bond market volatility (MOVE index). Both markets are looking for clarity on the policy outlook moving forward.

We believe markets are set up for a traditional post-election rally once election uncertainty is resolved. Economic growth remains solid, and the Federal Reserve (Fed) is cutting interest rates. Typically, such a configuration is bullish for asset prices.

Fixed Income Takeaways:

Last week, front-end Treasury yields moved higher once again. Traders are pricing in a slower pace of Fed rate cuts due to resilient economic growth, which has put some upward pressure on Treasury yields in recent weeks.

On Monday morning, yields moved 8-12 basis points lower, reversing some of last week’s increase. Overall, 2-year Treasuries were yielding 4.14%, 5-year Treasuries 4.13%, and 10-year Treasuries 4.28% in early Monday trading.

The Fed remains poised to cut interest rates by 25 basis points (0.50%) at this week’s November 7 meeting. Another 25 basis-point cut is expected at the December 18 meeting. The current Fed Funds rate is the range of 4.75% to 5.00%.

By the end of 2025, market participants are pricing in a Fed Funds rate of approximately 3.60%. If the Fed continues cutting rates and the Treasury curve normalizes to a traditional shape, fair value for the 10-year Treasury note is likely in the 4.50% to 5.00% range.

At their current level of approximately 2.00%, real yields (interest rates minus inflation) remain high compared to historical norms. Any time real yields are above zero, monetary policy is considered restrictive.

As the Fed cuts rates, private markets (both private equity and private credit) should benefit. Lower yields and improving liquidity are generally positive for private equity dealmaking. Lower yields benefit private credit by reducing the interest rate burden for borrowers, which should help lower the overall default rate.

Key Takeaways:

According to betting markets such as Predictit.org and Polymarket, Trump’s odds to win the presidential election climbed higher over the past week. The race remains too close to call, however.

These markets also suggest that divided government is the most likely outcome, with the Senate likely to flip Republican and the House essentially a 50/50 toss-up.

Key Wealth advises interpreting or relying on betting markets carefully as they are prone to considerable volatility, are not official polling results, and do not represent any type of endorsement or prediction by Key Wealth, Key Bank or any other affiliates.

Trump has slight polling leads in key swing states such as Arizona and Georgia, according to Real Clear Politics as of October 24, while Harris has a slight polling lead in Minnesota. Michigan, Nevada, North Carolina, Pennsylvania, and Wisconsin all have margins of less than 1%, according to the same polling data.

Volatility in both the stock and bond markets may increase as we approach the election.

Historically, stock market volatility increases around election day and typically sets up a post-election rally. The forward 12-month price/earnings (P/E) ratio for the S&P 500 is just shy of 22x, according to FactSet, an expensive level that suggests much good news is priced into the stock market.

Bond investors are also braced for increased volatility around the election. The MOVE index, a measure of bond market volatility, has increased to elevated levels.

Economic growth remains resilient.

Underpinning the recent strength in the stock market, economic growth remains solid. The Bloomberg U.S. Surprise Index, a measure of economic strength relative to expectations, has been increasing in recent weeks according to Bianco Research.

The Atlanta Fed GDPNow real GDP estimate for Q3:2024 has also been increasing slowly in recent weeks. This metric is projecting third quarter real GDP growth of more than 3%, a solid number that suggests continued expansion.

Over the long term, the high federal deficit remains a concern in plain sight – a “grey rhino” as opposed to a “black swan.” The federal deficit could push up long-term inflation, all else equal, but will likely not be addressed anytime soon.

Bottom Line:

Key Wealth did an analysis of S&P 500 returns in the one year after presidential elections with data back to 1960. In the 1-year after each presidential election from 1960–2020, the average S&P 500 return was 13.2%, and the median return was 12.6%. Patient investors have generally been rewarded.

Both stocks and bonds may be rangebound over the near term, as much good news appears priced in at these levels. Recession risks have likely fallen with the Fed's recent 0.50% interest rate cut, which should support stocks over an intermediate to long-term time horizon.

Remain Neutral to Risk and emphasize Quality investments. Employ small tactical tilts to areas that carry less-demanding valuations. Use New Tools, such as alternatives and real assets, where appropriate. Don’t let your politics undermine your financial goals.

Equity Takeaways:

Over the weekend, fears of a wider Israel-Iran conflict in the Middle East seem to have dissipated, which pushed stocks higher in early Monday trading. The S&P 500 rose 0.6% to 5841, while small caps rose approximately 1.4%. International shares were generally higher.

The uptrend in the S&P 500 remains intact after a very modest pullback last week. Five very large technology companies report this week. Strong earnings from these companies will be required to continue pushing the market higher.

This week will be one of the most important of the entire Q3:2024 reporting season. With the market relatively expensive on the price/earnings basis, strong earnings must continue to come through.

Oil prices dropped approximately 6% in early Monday trading, with West Texas Intermediate crude trading around $67.20. Gasoline and natural gas prices each fell 5-7%. The reduction in tensions between Israel and Iran caused the drop and continues the recent trend of lower energy prices.

Agricultural commodities, such as wheat and soybeans, have also seen prices fall steadily over the past several years. Precious metals, such as gold and silver, remain in an uptrend.

Fixed-Income Takeaways:

The Federal Reserve (Fed) is highly likely to cut the Fed Funds rate by another 25 basis points on November 7, to a range of 4.50% to 4.75%. Market participants are becoming worried that the Fed will not cut rates as much as expected going forward and are pushing up yields on longer-term bonds as a result.

Either higher-than-expected economic growth or stubborn inflation could reduce the pace of future Fed rate cuts. Indeed, bond yields were moving higher across the globe last week, as economic growth has been stronger than expected around the world in recent weeks.

In early Monday trading, 2-year Treasuries were yielding 4.13%, 5-year Treasuries 4.09%, and 10-year Treasuries 4.25%. Since the Fed’s rate cut on September 18, the yield on the 2-year Treasury note has risen approximately 50 basis points, while the yield on the 10-year Treasury has risen approximately 70 basis points.

This is the seventh time the Fed has initiated a rate-cutting cycle since 1989. No other cycle has seen as big an increase in yields in the wake of the initial cut, according to Bianco Research.

For context, Treasury yields had fallen sharply prior to the Fed’s initial rate cut in September. At its current level of approximately 4.25%, the 10-year Treasury yield is back to levels last seen in July of this year.

Election Update:

Online betting markets such as Predictit.org and Polymarket both suggest that Trump has built a slight lead in the race against Harris. These markets also suggest that a divided Congress is the most likely election outcome. Notably, betting markets do not provide any insights about one candidate’s expected margin of error over the other and they are not intended to be predictive like polls are. Rather, they merely reflect the mood of the betting crowd at a moment in time.

Key Wealth advises interpreting or relying on betting markets carefully as they are prone to considerable volatility, are not official polling results, and do not represent any type of endorsement or prediction by Key Wealth, Key Bank or any other affiliates.

The Republicans are seen as likely to gain control of the Senate, while the House is seen as a toss-up, according to Polymarket. The bipartisan Brookings Institute notes that Republicans have more vulnerability regarding the number of seats up for election in the House, while the Democrats have more vulnerability in the Senate.

Since 1928, in an average presidential election year, stocks struggle in the first five months of the year, rally over the summer, digest gains from Labor Day until the election, and finally launch a post-election rally, according to data provided by RenMac. 

During the current cycle, the stock market has performed much better year-to-date (YTD) compared to a typical presidential election year, displaying both above-average returns and above-average volatility according to RenMac data. Will we see a post-election rally, or have gains been pulled forward? Time will tell.

If the election results are uncertain for an extended period, the stock market would likely react negatively. For example, the NASDAQ fell 17% in the 35 days after the 2000 election, although the tech bubble was in the process of deflating in 2000 and would continue deflating for another 12 months.

The U.S. economy remains resilient.

The Atlanta Fed’s GDPNow estimate for Q3:2024 real GDP has moved above 3.0%, indicating continued solid growth in the economy. Redbook retail sales data, Open Table daily restaurant bookings, and US TSA air travel checkpoint numbers all point to continued solid discretionary spending, according to Apollo.

Extreme weather events, as well as a labor strike at a large company, have caused significant noise in weekly unemployment claims data. Recent comments from Federal Reserve (Fed) Governor Waller allude to these factors – the Fed is aware that labor market data may be volatile in the coming weeks.

Bottom Line:

Both stocks and bonds may be rangebound over the near term, as much good news appears priced in at these levels. Recession risks have likely fallen with the Fed's recent 0.50% interest rate cut, which should support stocks over an intermediate- to long-term time horizon.

Remain Neutral to Risk and emphasize Quality investments. Employ small tactical tilts to areas that carry less-demanding valuations. Use New Tools, such as alternatives and real assets, where appropriate. Don’t let your politics undermine your financial goals.

Equity Takeaways:

Stocks were mixed in early Monday trading. The S&P 500 was flat at 5,863, while small caps fell approximately 0.7%. International shares were generally lower.

This year is not running to historical patterns, as we did not see weakness in September (as is typical). In an election year, late October is typically weak as well. Our worry is that we may have pulled forward traditional post-election gains, but only time will tell.

With third quarter 2024 earnings season fully underway, forward earnings per share (EPS) estimates for the S&P 500 have moved to new cycle highs. In Q3:2024, the technology sector is poised for the fastest year over year earnings growth, but as we move forward into Q4:2024, sectors like financials and health care are poised to pick up the baton according to FactSet. Broadening earnings growth is a positive signal.

That said, the overall S&P 500 remains expensive. The forward price/earnings (P/E) ratio is 21.8, a level where forward stock market returns become muted according to Apollo.

Gold stocks are a sub-sector that looks very strong on a technical basis. Gold stocks are breaking above resistance out of a multi-year basing pattern. The underlying metal price has been strong, and the stocks are playing catch up.

Fixed-Income Takeaways:

Treasury yields were stable last week, moving by just a few basis points across the curve. Also, 10-year Treasuries have settled into a range with yields just above 4.0%. Investors are still pricing more than a 90% chance of a 25 basis-point rate cut at the Fed’s upcoming November 7 meeting. The current Fed Funds rate is the range of 4.75% to 5.00%.

In early Monday trading, yields rose 4–7 basis points across the curve. In summary, 2-year Treasuries were yielding 4.01%, 5-year Treasuries 3.95%, and 10-year Treasuries 4.15%.

Corporate credit remains well bid. Investors are looking to lock in yield, even with BBB-rated corporate bond spreads at their tightest levels since 1998. As long as the 10-year yield stays above 4.00% and the economy remains resilient, corporate bond spreads will likely remain tight, as investors remain attracted to all-in yields around 5.00%. 

Floating-rate yields have declined over the past month, but we have not yet seen investor outflows. The yield on floating-rate securities is tied to short-term interest rates. As the Fed cuts rates, these yields will fall. Investors in floating-rate securities may want to consider adding some fixed-rate exposure to bond portfolios.

Bond investors are bracing for more volatility as the election approaches. The MOVE index, a measure of volatility in the bond market, moved higher in early October. This index looks 30 days forward and implies that investors expect increased volatility in the bond market after the election. At the same time, the VIX index, a measure of stock market volatility, has moved lower in recent weeks.

Key Takeaways:

Election Day is three weeks away.

Based on data from Renaissance Macro, during most presidential election years, stocks struggle in the first five months of the year relative to historic norms, rally in the summer, digest gains prior to the election, and rally into year-end once the election has been completed.

This year, stocks have displayed above-average volatility but have also enjoyed above-average returns. Have gains been pulled forward this year, or will we see a typical post-election rally? Time will tell.

Investors should not let politics undermine their financial goals. A $1,000 investment in US stocks since President Eisenhower was inaugurated in 1953 would have grown to more than $1.6 million today, according to data from Bespoke. The same $1,000 invested only during Republican or Democratic administrations since 1953 would have grown to a small fraction of that amount.

Initial weekly unemployment claims rose to 258,000 from 225,000 the week prior.

Weekly unemployment claim data is a leading indicator for the labor market, so on the surface, a quick rise in claims is cause for concern. That said, the data likely contains significant noise due to recent weather events.

The recent rise in weekly unemployment claims to 258,000 for the week ending October 5, 2024, may be related to recent hurricane activity. Back in 2005, in the week after Hurricane Katrina, initial claims rose by more than 100,000 before quickly receding back to the prior trend. For 2024, multiple weeks in October may be affected, given two hurricanes occurred back-to-back.

Inflation is cooling, but still not completely cool.

Falling energy prices helped the headline Consumer Price Index (CPI) fall to 2.41% year over year in September, its slowest rate of growth since early 2021. The core CPI, which strips out food and energy prices, rose 3.26% year over year in September, and has been stuck around 3.3% year over year since June.

In September, the housing component of the CPI grew at its slowest rate in three years. Services prices excluding Housing reaccelerated from the prior month. If inflation remains stubborn, the Federal Reserve (Fed) may not cut rates as quickly as market participants expect.

Bottom Line:

Both stocks and bonds may be rangebound over the near term, as much good news appears priced in at these levels. Recession risks have likely fallen with the Fed's recent 0.50% interest rate cut, which should support stocks over an intermediate- to long-term time horizon.

Remain Neutral to Risk and emphasize Quality investments. Employ small tactical tilts to areas that carry less-demanding valuations. Use New Tools, such as alternatives and real assets, where appropriate.

Equity Takeaways:

Stocks were mixed in early Tuesday trading. The S&P 500 was flat at 5859, while small caps rose approximately 0.9%. International shares were generally lower, led by Chinese shares.

Counter to normal seasonal patterns, the S&P 500 broke out to a new all-time high in September. Continued strong earnings have supported stock prices. Whenever the market defies traditional patterns, it is best to pay attention to the message of the market.

Recently, the S&P 500 has been driven higher by financials and industrials (cyclical sectors). Large technology companies (the Magnificent 7) have not been leadership. Typically, cyclical leadership is bullish for stock prices. If large technology companies do not completely roll over, the S&P 500 should continue to grind higher.

The forward price/earnings (P/E) ratio on the S&P 500 is 21.8x, an elevated level. In recent years, the stock market has had trouble moving above a 22x P/E multiple. Other measures of valuation, such as price/sales, price/book, and price/cash flow, tell a similar story – the stock market is relatively expensive.

Valuation is a poor short-term market timing tool. Valuation is better used as a gauge on long-term expected returns. A high valuation implies that some level of returns may have been pulled forward.

This week marks the two-year anniversary of a bull market that began on 10/12/22. Since that date, the S&P 500 has risen 64%. US stocks have outperformed major global indices over that timeframe, led by technology shares. The average bull market lasts approximately four years.

In the past two years, S&P 500 earnings grew approximately 14%, while the S&P 500 index rose 64%. Multiple expansion has led to many of the gains in the stock market. US markets also have a structural advantage relative to global markets, with higher concentrations in faster growing sectors such as technology, which has supported returns.

Fixed Income Takeaways:

Bond market participants have become very sensitive to Fed commentary in recent weeks amidst conflicting economic data. While inflation is dropping slowly, it remains elevated relative to the Fed’s long-term target of 2%. The pace of Fed rate cuts may slow in the coming months as a result.

After the Fed cut interest rates by 50 basis points in mid-September, Treasury yields have counter-intuitively moved higher. More specifically, 10-year Treasury yields have moved above 4% in recent weeks. Typically, investors step in to buy once yields hit 4%. Recent Treasury supply has been elevated, counterbalancing some of this demand.

In early Tuesday trading, 2-year Treasuries were yielding 3.96%, 5-year Treasuries 3.88% and 10-year Treasuries 4.05%.

Corporate bonds and mortgage-backed securities continued to see strong demand last week. Credit spreads tightened once again, with the broad investment-grade (IG) index tightening to 80 basis points.

The all-time tightest spread level in the IG index was 75 basis points in 2005. That said, the credit quality of the index is likely higher today compared to 2005.