Key Private Bank Investment Brief

Key Takeaways:

Election Update:

The “swingiest” of swing states (AZ, GA, MI, PA, and WI) have swung from Democrat to Republican, previously from Republican to Democrat, and now back from Democrat to Republican over the past three elections. These states propelled Trump to victory.

Republicans gained seats in the Senate and now have a 53-47 majority. The House is leaning Republican as well – a red sweep is looking likely, although not all results are final. Any Republican majority in the House is likely to be narrow.

Elections don’t cause recessions. Credit spreads are a more reliable (although not perfect) precursor to recessions. Credit spreads were very well behaved prior to the election, and now that the election is complete, equity market volatility has fallen again (predictably).

In the week after the election, stocks traded similarly to the period after Trump’s 2016 victory. In the period from 11/8/16 to 12/31/16, the S&P 500 rose 4.6%, the Nasdaq Composite rose 3.7%, and the small cap Russell 2000 rose 13.5%, according to data from DataTrek. Fast forward back to 2024: in the past week, the S&P 500 rose 4.7%, the Nasdaq Composite rose 5.1%, and the Russell 2000 rose 10.0%, also according to DataTrek.

The stock market is more expensive now than it was in 2016. Inflation is also higher. The forward price/earnings (P/E) ratio on the S&P 500 is approximately 22.2x currently, versus 16.5x in 2016, according to FactSet. At the same time, the year-over-year rate of change in core inflation was 2.2% through September 2016, versus 3.3% through September 2024.

Bottom Line:

Irrespective of one’s political preferences, most agree that the election was convincing: Trump will return to the White House, and the Republicans will control Congress (albeit with a small margin in the House).

The removal of uncertainty is responsible for a large amount of the rally in risk assets, but several “Trump trades” are adding additional fuel to the stock market’s rise. While some of this may be justified, selectivity is very much warranted in our view, and much uncertainty remains.

At the same time, relative to 2016, today’s labor market is slowing, inflation is higher and sticky, and valuations are considerably higher.

Finally, as we’ve seen in the past several elections, change is the only constant, and thus the political climate may soon change yet again.

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 Tuesday trading. The S&P 500 rose approximately 0.1%, to 6007. Small caps drifted slightly lower. International shares were mixed.

The removal of uncertainty around the election process has driven the stock market higher over the past week. Last week’s clear winner pushed the S&P 500 to an all-time high. Small caps have also rallied sharply. The dollar has also risen, putting pressure on international stocks.

The latest move higher was driven completely by P/E multiple expansion. Estimates for 12-month forward earnings-per-share (EPS) for the S&P 500 have flattened over the past several weeks, while the index itself has rallied in price.

With the P/E multiple for the broad market trading above 22x, further multiple expansion will be challenging. Put another way, earnings growth will be necessary going forward to push the broader market higher.

Cyclical sectors of the market, such as financials and industrials, have been in an uptrend relative to defensives, such as consumer staples, for quite some time. Trump’s victory lit a fire under cyclicals, which continued to outperform versus defensives last week.

Small caps are also an obvious “America First” beneficiary and have rallied sharply over the past week. Small caps have little exposure to international markets. That said, unlike the S&P 500, the Russell 2000 index has not yet hit an all-time high. In addition, small caps have been lagging relative to large caps and need to show better relative strength before we’re ready to get more bullish on a relative basis.

Fixed-Income Takeaways:

Last week, short-term Treasury yields moved higher compared to long-term Treasury yields, resulting in a “bear flattener.” In early Tuesday trading, 2-year Treasuries were yielding 4.33%, 5-year Treasuries 4.27%, and 10-year Treasuries 4.37%.

Initially after the election, 10-year Treasury yields moved 21 basis points higher, to an intra-week high of 4.48%, before grinding lower later in the week.

Trump’s proposed economic policies have the potential to increase growth and inflation. As a result, market participants have significantly reduced their expectations for future rate cuts.

The Federal Reserve (Fed) cut the Fed Funds rate by 25 basis points last week, to the range of 4.50% to 4.75%. Over the next year, a total of 75-100 basis points of additional rate cuts are priced into the markets. Several months ago, more significant rate cuts were priced in for expectations. Treasury market volatility has been high and tends to increase when Fed policy is uncertain.

Despite volatility in the Treasury market, credit spreads have continued to narrow. Both high-yield and investment-grade spreads are very tight relative to history. High-yield spreads tend to track equities. High-yield borrowers should also benefit from any extension of corporate tax cuts.

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.