Investment Brief (Archive)

2023 Key Private Bank Investment Briefing Notes

Key Takeaways

2023 year-to-date (YTD) financial market performance has been a mirror image of 2022. Why?

  1. Inflation is moderating in the US. Additionally, warm weather in Europe has led to lower energy prices in that part of the world, taking a worst-case inflationary scenario off the table for now. Finally, the Chinese economy is reopening, supporting global growth.

  2. Optimism around both the trajectory of corporate earnings growth, as well as Federal Reserve policy becoming less hawkish, has also supported asset prices.

    1. Wall Street analysts are projecting about 3% earnings growth for the 2023 calendar year, improving to almost 11% growth in 2024.

    2. The Federal Reserve (Fed) is expected to raise rates from 4.50% to 5.00% by the end of March (25 basis point increases at each of the next two Fed meetings). That said, interest rate futures curves are predicting a pivot to rate cuts as early as mid-summer.

Bottom Line:

  • The market may be over-optimistic in the short term regarding some of the issues above.

  • While the economy showed relatively strong growth in Q4:2022, growth is likely to slow in Q1:2023. The labor market remains tight.

  • Get “neutral to risk,” emphasize quality, and remain diversified.

  • Correlations between stock and bond prices increased significantly in 2022 as inflation and bond yields both rose. With bond yields now significantly higher, and the Fed moving toward a pause, bonds should provide improved diversification in 2023.

Equity Takeaways

Stocks ticked lower in early Monday trading. The S&P 500 fell about 0.5%, with small caps down a similar amount. The tech-heavy Nasdaq fell about 1%. International shares were also lower.

The S&P 500 has been in a descending downtrend channel for over a year. Last week, it broke through the upper end of this channel, a positive sign. Earnings have been “good enough” to push us higher. Underlying breadth remains strong. A sustained move above 4100 would point us toward 4300 (the August 2022 highs).

Cyclicals, Industrials, and Materials are leading – these are typically bull market sectors. Semiconductors have also rallied sharply. Consumer Discretionary stocks (another “risk on” sector) continue to lag; however, the technical picture of the market looks good overall.

Short covering (buying back stocks to cover previous short sales) has buoyed equity market performance YTD. High-beta stocks have shown significant outperformance versus the broader market YTD, bouncing back from a very weak 2022. Conversely, minimum volatility stocks, which held up much better than the broader market in 2022, have underperformed YTD in 2023.

In addition to short covering, much of the recent rally has likely been driven by loosening financial conditions (as measured by the Goldman Sachs US Financial Conditions Index). Tighter credit spreads and a weaker US dollar have eased financial conditions. Even with the Fed Funds rate 200 basis points higher since last August, financial conditions have eased during that time.

The market is expecting a pivot to lower rates in 2023 by the Fed. If the Fed simply pauses at a 5.00% Fed Funds rate (rather than lowering), stock market participants will likely be disappointed, which could lead to tough trading later in the year.

Corporate earnings growth is slowing compared to prior years – momentum is coming out of the earnings line. Earnings are not falling off a cliff but will likely remain under pressure throughout 2023.

With approximately 30% of S&P 500 companies having reported Q4:2022 results, 60% of companies have beaten Wall Street’s revenue estimates, which is below the 5-year average of 69%. On the earnings side, 69% of companies have beaten earnings estimates, which is also below the 5-year average of 77%.

Fixed Income Takeaways

The 2-year US Treasury yield has traded below the Fed Funds rate since mid-December. Historically, when the 2-year Treasury yield has traded consistently below the Fed Funds rate, the Fed has been close to rate cuts (typically cutting rates within 90 days).

Based on recent communications, Fed officials are nowhere near cutting rates. When markets and the Fed are at odds, volatility in asset prices can result.

As noted above, the Fed is poised to increase the Fed Funds rate by another 25 basis points (bps) this week on Wednesday, to a range of 4.50% to 4.75%. The current 2-year Treasury yield is approximately 4.25%.

The consensus view is that the Fed will likely increase interest rates by 25 bps this week, and another 25 bps in March, before pausing, with the Fed Funds rate at 5.00%. In the second half of 2023, market participants expect rate cuts, but the Fed has given no such guidance.

The tone of the fixed income markets has been “risk on,” in conjunction with a strong equity market in 2023. New issuance levels have been robust, and credit spreads remain firm.

Key Takeaways

  1. Debt ceiling drama is receiving more attention.

    • Other things will soon retake the primary market narrative, but the debt ceiling may remain an overhang for much of 2023.

    • The debt ceiling debate is essentially a manufactured crisis over the US government’s willingness to pay its debt. It is not a debate about the government’s ability to pay.

  2. Investors should anticipate volatility but be prepared to embrace it.

    • The debt ceiling is not likely to be raised quickly. Investors should not overreact to short-term headlines.

    • The debt ceiling has been in place since 1917. The debt ceiling was amended during World War II and has been raised nearly 100 times since. We do not believe that the US will default on its debt.

  3. Bigger, longer-term issues require continued assessment.

    • Inflation is cooling, but absolute levels remain elevated. The labor market is beginning to slow but remains strong overall. Fourth Quarter 2022 GDP estimates continue to look solid.

    • The Federal Reserve (Fed) is likely to slow its pace of rate hikes in the coming months but will not likely pivot towards rate cuts anytime soon. Market participants continue to expect rate cuts in late 2023, which is at odds with current Fed guidance.

    • In our view, the Federal Reserve is watching the labor market/unemployment rate very closely. Until we see a more pronounced weakness in the labor market, Fed policy is likely to remain tight.

    • Corporate profits are falling. Net profit margins are returning to pre-COVID levels. Corporate profit weakness is potentially the biggest risk for markets in 2023.

Bottom line:

  • Be selective, emphasize quality and remain fully diversified.

  • Key continues to recommend additional diversification in the form of alternatives and real assets where appropriate. These types of strategies generally outperformed traditional stocks and bonds in 2022.

Equity Takeaways

Stocks rose in early Monday trading. The S&P 500 rose about 0.4%, with small caps up a similar amount. International shares were mixed.

Global stock markets are off to a strong start in 2023. Through last Friday, the S&P 500 was up 3.6% year-to-date (YTD), while the small cap S&P 600 was up 5.8% YTD. Large-cap growth stocks have rallied about 3%, while large-cap value stocks are about 4.2% higher YTD. International shares (both developed and emerging markets) have rallied between 7 and 8% YTD.

The bulk of the fourth quarter earnings season will occur in the next two weeks. Thus far, with 10-15% of S&P 500 companies having reported, about 67% have beaten Wall Street estimates. In recent quarters, the beat rate has been 75-80% – earnings are clearly slowing.

So far this quarter, companies that miss on revenue and earnings are not being penalized in the marketplace as much as normal. A similar pattern is being shown for companies that beat on revenue and earnings, which are not being rewarded as much as normal.

In other words, the stock market is looking past this quarter, and is looking out 6-9 months. Market participants are more concerned with the macroeconomic outlook than short-term earnings weakness.

The forward economic outlook (and the ensuing impact on corporate earnings) will be key for 2023 stock market performance. The Fed’s sharp rate hiking program is fully priced in at this point.

Fixed Income Takeaways

As with stocks, bonds are off to a strong start in 2023. Core taxable bonds, municipal bonds, and high-yield credits have all rallied in the range of 2-4% YTD. Credit spreads remain resilient, and new issuance levels have rebounded sharply.

Treasury yields moved lower last week. Two-to five-year Treasury yields fell about 5 basis points, while 10-year Treasury yields fell 2 basis points. Treasury curves remain sharply inverted.

Economic data were generally weaker than expected last week, with items like retail sales missing to the downside. Producer Price Inflation (PPI) data were also lower than expected.

Several Federal Reserve speakers continued to stress inflation as the Fed’s greatest concern last week. While these comments were interpreted as hawkish, the Fed is now telegraphing a 25 basis-point hike at its upcoming meeting in early February, which is a slower rate of change than we saw for most of 2022. The current Fed Funds rate is 4.25% to 4.50% – it is expected to peak at about 5.0% in mid-2023.

Key Takeaways

  1. Inflation is cooling, but it remains elevated.

    • The headline Consumer Price Index (CPI) fell 0.1% in December, which was the slowest month-over-month change in the past two-and-a-half years. Headline CPI peaked at 9.1% year-over-year in June 2022; in December, CPI rose 6.5% year-over-year.

    • Comparisons will get even easier over the next six months (due to sharp inflation increases around this time last year – this concept is known as a higher “base effect”).

    • Durable Goods inflation, which peaked at over 15% in early 2022, cratered to -0.1% year-over-year in December. Services inflation (excluding rent of shelter) and Food inflation have both proven to be stickier, rising 7.4% and 10.4% year-over-year, respectively, in December.

    • Typically, the Federal Reserve (Fed) does not stop raising interest rates until the Fed Funds rate moves above the headline CPI number.

  2. The economy is slowing, but it remains resilient.

    • The Atlanta Federal Reserve GDPNow estimate for Q4:2022 real GDP is about 4.0%, implying that the economy finished 2022 on a relatively strong note.

  3. Stocks and bonds are off to a good start in 2023, but they remain correlated.

    • The S&P 500 has risen 4.2% year-to-date (YTD), while core bonds have risen 3.0%. Small caps have risen 7.1% YTD, outperforming large caps, while value has outpaced growth 5.8% to 2.8%. Municipal bonds have risen about 1.9% YTD.

    • Since 1940, after a year in which the S&P 500 fell at least 25% peak-to-trough, forward returns have tended to be above average across the ensuing 1-year, 3-year and 5-year time horizons.

  4. The US debt ceiling debate could cause some short-term volatility over the next few months, but any decline is likely to be a long-term buying opportunity.

    • In 2011, a downgrade of US debt did cause a short-term pullback, but stock prices regained their footing relatively quickly and continued to rally for most of the ensuing decade.

    • The debt ceiling is a political construct – underlying economic growth will be much more important to future asset prices.

While we have signaled that 2023 could bring about more gridlock and it might not be viewed as a good thing, we think it is ill-advised to make investment decisions based on one’s political views or speculating on what might (or might not) happen within the political arena. Political machinations make for good TV, but are largely noise, and even if we reach another “market event” (i.e., a debt downgrade/technical default), such events are usually short-lived and represent great buying opportunities.

So, in sum, tune out the noise, stay diversified, and be willing to embrace volatility versus trying to time or shun it.

Equity Takeaways

Stocks rose slightly in early Tuesday trading, continuing the strength seen early in 2023. The S&P 500 rose about 0.3%, while small caps rose about 0.2%. International shares were generally higher.

Wall Street analyst forward earnings estimates have fallen in recent months. However, the stock market has not seemed to care, and has instead shown surprising strength. Perhaps the stock market is telegraphing earnings surprises to the upside (against lowered estimates).

The Russell 3000 (a very broad index of both large and small-cap stocks) recently underwent a “breadth thrust.” More than 50% of Russell 3000 components reached a new 20-day high, as of last Thursday. Typically, this type of signal is unabashedly positive for the stock market.

In addition, the average stock (as measured by the Value Line Arithmetic index) is showing strength versus the market-cap-weighted S&P 500. The average stock has been leading the market higher over the past few weeks, another sign of improving breadth.

With the average stock outperforming the broader indices, the environment is ripe for active management. Going into 2023, equity fund managers generally favor high-quality companies, value stocks, and small caps. Conversely, fund managers are generally underweight large-cap growth.

Fixed Income Takeaways

Treasury yields continued to drop last week. Both the 3-month/10-year and 2-year/10-year Treasury curves remain deeply inverted. As we have noted in the past, significant curve inversions indicate that market participants expect growth and inflation to slow.

Credit spreads peaked over the summer in 2022 and have been generally trending lower ever since. This trend continued last week, with weaker credits outperforming across the credit curve in both the investment-grade and high-yield sectors. The bond market was in “risk on” mode.

For example, BB-rated spreads peaked at 419 basis points over Treasuries last summer. As of last Thursday, BB-rated spreads had dropped to 274 basis points. BB-rated bonds are on the upper end of the high-yield spectrum in terms of credit quality.

Fixed income fund managers generally believe that inflation has peaked and expect it to return to the 2% area by mid-2024. Managers are generally overweight credit products versus their respective benchmarks (credit losses remained benign in 2022).

Key Takeaways

Our Outlook in a Nutshell:

Bad News: a recession in 2023 seems likely, but we do not think it will be a historic one.

Good News: inflation should ease in 2023 and interest rates should peak. A pause in rate hikes by the Federal Reserve (Fed) seems more likely than a pivot to lower rates.

Stocks: a wide range of outcomes is expected. Stay selective – tilt to value and small caps.

Bonds: there is income in fixed income again. Continue to emphasize quality.

New Tools: intentionally expand your definition of diversification. Continue utilizing alternatives and real assets where appropriate.

Bottom line: the US economy is transitioning toward a period of elevated inflation amidst slowing growth, and the 2009-2021 investment playbook may no longer apply. 

The 2009-2021 period was characterized by a highly stimulative Fed amidst dormant inflation, which favored growth stocks and passive investing (the rising tide lifted all boats). Going forward, a continued shift toward value stocks in a higher-rate environment that favors active management is possible.

The minutes from the Fed’s December meeting were released last week. Federal Reserve officials reaffirmed their resolve to bring inflation down and, in an unusually blunt warning to investors, cautioned against underestimating their policy to keep rates high for some time. More details are below.

Late in 2022, the SECURE 2.0 Act was passed. Please contact your relationship team for more information on how this important retirement reform legislation could affect you.

Equity Takeaways

Building on a strong day last Friday, stocks rose in early Monday trading. The S&P 500 rose about 0.9%, while small caps rose about 0.7%. International shares also rose.

Fed policy is likely to remain a headwind for equities in 2023. The recent Fed minutes noted that “an unwarranted easing in financial conditions would complicate the Committee’s effort to restore price stability.”

The term “financial conditions” is the Federal Reserve’s term for stock prices and credit spreads. In other words, the Fed believes that a sharp rally in stock prices could hinder their efforts to control inflation.

Fixed income yields have risen, presenting a valuation challenge to equities. As yields have become more attractive in high-quality fixed income, money may move from equities toward fixed income. At the same time, projected corporate earnings growth continues to slow.

The stock market has been resilient over the past few weeks, but on a technical basis, the charts of many large technology companies still look bearish. We could see a near-term bounce towards 4100 from the S&P’s current level of about 3900, but we continue to expect choppy trading in 2023.

The consensus among market participants is for a weak first half of 2023 in stocks, followed by a strong second half of the year. Consensus is not usually correct. It would not surprise us to see a stronger-than-expected first half of 2023, followed by a weak second half. Overall, the market is still set up for a tough year.

As measured by the Value Line Arithmetic Index, the average stock has been outperforming the S&P 500 index since early 2022. This dynamic indicates a good environment for stock picking.

International Stock Update:

Strength in the US Dollar was a major headwind to international equities in 2022. Despite these currency headwinds, international stocks did provide diversification benefits for US investors in 2022.

Within Europe, energy market volatility remains a primary concern. Energy prices have moderated recently due to warmer-than-expected weather, but volatility is likely to persist.

Japanese corporations produced record profits in 2022, but wage growth remains sluggish and has weighed on sentiment.

Emerging market (EM) returns were negatively impacted in 2022 by China’s zero-COVID policy. Going forward, as China reopens, sentiment surrounding Chinese equities may improve.

In general, emerging market equities tend to struggle in a rising rate environment. This cycle could be different in that EM economies (including China) are less reliant on US dollar financing than in the past.

Fixed Income Takeaways

Intermediate-to long-term Treasury yields dropped sharply last week, partially in response to lower-than-expected average hourly earnings data in last Friday’s nonfarm payroll employment report. For example, 5-year Treasury yields entered the year around 4.0% and had dropped to about 3.7% in early Monday trading.

Falling long-term Treasury yields have resulted in further Treasury curve inversion. In early Monday trading, the 3-month Treasury bill yielded 4.61%, while 10-year Treasury notes yielded 3.59%. As we have noted in the past, short-term Treasury yields are very sensitive to Fed rate policy, while longer-term yields are linked to long-term growth and inflation expectations.

It is very unusual to see a 3-month/10-year Treasury curve inversion of over 100 basis points. The magnitude of this inversion suggests that market participants believe economic growth and inflation will markedly slow in 2023.

New corporate bond issuance picked up sharply last week as borrowers took advantage of lower yields across the investment-grade (IG) spectrum.

The Federal Reserve is expected to continue raising rates over the next few months, but in smaller increments. The terminal Fed Funds rate is expected to peak around 5% in the first quarter of 2023 (the current Fed Funds rate is 4.25% to 4.50%).

In recently released Federal Reserve minutes, not a single Fed official predicted rate cuts in 2023. This outlook is in marked contrast with bond market expectations, which continue to anticipate rate cuts toward the end of 2023 amidst a slowing economy.

2022 Key Private Bank Investment Briefing Notes

Key Takeaways

The average Wall Street strategist sees 2023 as a “down” year for stocks. However, these forecasts have an unusually large amount of dispersion, indicating confusion amongst prognosticators. Individual company earnings estimates are seeing similar dispersion.

The Federal Reserve (Fed) is also uncertain. The Fed’s outlook for interest rates shows very wide dispersion in the 2024-2025 timeframe. Most Fed governors believe that some amount of rate cuts will be appropriate starting in 2024, but the projected amount varies greatly.

Market participants do not believe the Fed’s forecast for interest rates. Forward market rate expectations are pricing a peak (terminal) Fed Funds rate of 4.85% in mid-2023, versus the Fed’s own projections of 5.125%. In addition, market participants believe the Fed Funds rate will move towards 4.50% by year-end 2023, versus Fed projections of 5.125%. Simply put, these differences in projections indicate the market thinks the Fed will begin lowering the Fed Funds rate before the Fed thinks it will.

November showed the lowest overall month-over-month increase in the core Consumer Price Index (CPI) since mid-2021. That said, core CPI still rose 6% year-over-year. Core inflation is coming down but remains elevated.

Goods inflation has dropped sharply; conversely, services inflation, which is largely driven by shelter prices and wages, has remained higher for longer. At the same time, the housing market is slowing, so shelter inflation should moderate as we move through 2023. On the other hand, wage growth remains strong due to the tight labor market and has shown little sign of moderating.

Financial conditions are clearly tightening per the Fed’s design. US money supply growth is slowing sharply, with real M2 showing a 7.2% decline year-over-year in December. These tightening conditions are feeding through to the broader economy, which is slowing.

Despite a slowing economy, reasons for optimism remain as we enter 2023. For example, consumers are still flush with excess savings (to the tune of roughly $1.5 trillion), and total consumer net worth has risen about 30% over the past three years. The credit markets remain healthy and slowing inflation should be a tailwind across many areas of the economy.

The private real estate market has garnered much attention recently. Several large private real estate funds recently limited quarterly redemptions (also known as imposing “gates”), due to large withdrawal requests. These funds are not on Key’s recommended list.

That being said, we do recommend several private real estate funds and still believe in the diversification benefits of commercial real estate. We will provide a more detailed update on this asset class on a special client call in January.

Equity Takeaways

Stocks dipped slightly in early Monday trading. The S&P 500 fell about 0.4%, with small caps down a similar amount. International shares were mixed.

Monday will likely be a fairly normal trading day, but as we move towards the end of the week, liquidity will dry up. The last two weeks of the year are usually the lowest liquidity period of the year.

In addition to slow trading volume around the holidays, corporate buybacks will slow over the next few weeks as Q4:2022 earnings season approaches. Corporations are prohibited from repurchasing stock during a blackout window around their respective earnings release dates.

Market participants have still not gotten the Fed’s message. The 2-year Treasury yield is trading below the Fed Funds rate, which is a very unusual dynamic. This is an indication that market participants believe Fed policy is too tight.

In these types of situations, sometimes the market gets its way, but the disconnect could create additional volatility. The Fed has been steadfast in their message that they plan on continuing to raise rates towards the range of 5.00% to 5.25% as we move into 2023.

Fixed Income Takeaways

In a move that was widely expected, the Fed raised the Fed Funds rate by 50 basis points (0.50%) last week, to a range of 4.25% to 4.50%. Interestingly, Treasury yields fell across the curve in reaction to this move: 2-year Treasury yields fell about 17 basis points, while 10-year Treasury yields fell 10 basis points.

In early Monday trading, the 2-year Treasury yielded 4.22%, while 10-year Treasuries yielded 3.58%.

The Fed’s terminal rate forecast is now 5.125%. Prior to last week’s Fed meeting, market participants had expected a terminal rate of about 4.8%. After the meeting and press conference, market expectations for the terminal rate were unchanged, despite continued hawkish rhetoric from Fed Chairman Jerome Powell.

Interestingly, the market is anticipating about 50 basis points of rate cuts in late 2023, while the Fed is not predicting any cuts until 2024. The only way of resolving this type of disconnect will be through more volatility.

Credit spreads have held up well recently. High-quality corporate bonds are now yielding over 5%. Shorter-duration high-quality credits offer good value in the current environment.

Within high-yield bonds, CCC-rated credits continue to underperform. Investors are moving up in quality in this area of the market as well.

“We will stay the course until the job is done.” Fed Hawks continue to squawk – inflation is still too high and ongoing rate hikes remain appropriate.

Key Takeaways

  • The Federal Open Market Committee (FOMC) increased the target range for the Federal Funds rate by 0.50%, bringing the range to a level of 4.25% to 4.50%. This was a unanimous decision.

  • Monetary policy stance is not yet sufficiently restrictive.

  • Imbalances remain in the labor market.

  • Future direction of rate decisions will depend on incoming economic data.

  • The median forecast from the Summary of Economic Projections (SEP) shows Federal Funds interest rates at 5.1% in 2023 and 4.1% in 2024.

  • 17 of the 19 members of the Committee project that rates will be above 5.0% at the end of 2023.

Meeting Highlights

The FOMC raised the benchmark Federal Funds rate today by 0.50%, setting the target range at 4.25% to 4.50%. This is the highest level in 15 years, and marks the seventh consecutive interest rate hike this year.

Fed Chairman Jerome Powell mentioned in his press conference that the Committee still believes that inflation is too high and is currently monitoring the wide range of associated risks. It was noted that when establishing a pace for future rate hikes, the Committee will review cumulative tightening, and economic and financial developments, and policy lags.

Summary of Economic Projections

No meaningful changes were noted in the FOMC statement language, but the most relevant update came from the Summary of Economic Projections (SEP). The median Federal Funds rate forecast for 2023 released today was increased to 5.1% from 4.6% back at the September meeting – indicating that the new terminal range is set somewhere between 5.00% and 5.25% for 2023. This shows the potential for an additional 0.75% in rate hikes between now and the March 2023 meeting. At this time, it appears there will be a 0.50% hike at the February meeting followed by a 0.25% increase at the March meeting. Powell remained noncommittal during the press conference regarding the size of future rate hikes and noted that “decisions will depend on the totality of economic data.”

Additionally, the Committee is projecting Gross Domestic Product (GDP) will be 0.50% in 2023, which is down from the 1.2% in the September projections.

GDP is expected to advance by 1.6% in 2024 and 1.8% in 2025. The median unemployment rate is seen rising from 3.7% currently to 4.6% in 2023 and 2024 and decreasing slightly to 4.5% in 2025.

Chair Powell was adamant that more work needs to be done to get inflation back in line with their 2% target. Again, he noted the continued imbalance in the labor market and low unemployment as the catalysts for their vigilance and conviction to continue raising interest rates.

Bond Market Reaction

Initially, the bond market perceived the FOMC rate announcement as hawkish, which caused 2-year and 10­-year Treasury yields to move higher as the curve flattened, but this was short-lived as yields retreated when there was little pushback from Powell during the press conference on slowing the pace of rate hikes to 0.25% at the February meeting.

Our Outlook

In summary, based on today’s comments from Chair Powell and in conjunction with repeated language from prior FOMC meetings, we believe the Fed will hold interest rates higher for longer until it reaches its goal of reducing inflation back to its normal desired level of 2%. We anticipate the Fed would not consider reducing rates any time soon, unless or until the employment picture were to suffer and/or the economy were to experience a recession worse than expected.

Key Takeaways

2023 Economic Outlook: Was a pound of medicine worth an ounce of cure?

  • The biggest influence on the financial markets in 2022 has been the heavy hammer the Federal Reserve (Fed) applied to slow inflation (“a pound of medicine”).

  • To date, when looking at certain closely watched indicators, the Fed’s actions have only had a modest effect (“an ounce of cure”).

  • Looking deeper and peering ahead, some economic pain has been inflicted and the fever appears to be gradually breaking within certain areas of the economy.

  • Still, other aspects of inflation are proving stickier, and thus while it will decline, inflation will not likely fall to pre-COVID levels leaving the Fed with few good options.

Four Big Questions for 2023 (and our answers)

Q: Will inflation persist?
A: Inflation will slow but remain above the Fed’s target rate of 2%.

Q: How will the Fed respond and how will the economy perform?
A: The Fed will keep interest rates higher for longer, and the economy will slow.

Q: Will the US have a recession?
A: Most likely, but we do not expect it will be a historic one. A mild recession or “softish” landing is our base case. A hard landing/deep recession is possible, but not as likely as our base case in our view.

Q: What does this outlook mean for your portfolio?
A: Emphasize quality investments, remain selective and incorporate “new tools,” such as alternatives and real assets.

2023 Outlook Key Takeaways

  1. Bad News – recession seems likely, but we do not think it will be a historic one.

  2. Good News – inflation should ease, and interest rates should peak. A Fed pause seems more likely than a pivot to rate cuts, however.

  3. Stocks – a wider range of outcomes than normal. Stay selective – tilt to value and small caps.

  4. Bonds – there is income in fixed income again. Continue to emphasize quality investments.

  5. New Tools – continue to expand your definition of diversification.

Equity Takeaways

Stocks were essentially flat in early Monday trading. The S&P 500 rose about 0.2%, while small caps fell a similar amount. International shares were also slightly lower.

Only 14 trading days remain in 2022. This week’s trading will be dominated by the release of Consumer Price Index (CPI) inflation data on Tuesday, and the Federal Reserve meeting on Wednesday.

Typically, the market tends to rally in December (the proverbial Santa Claus rally). However, when trailing 12-month returns are negative coming into December, the “Santa effect” is muted.

Recently, the S&P 500 failed to breach overhead resistance at the 4100 level (September highs/top of downtrend level). Thus, the market remains in a down-trending channel. To get more bullish, we need to see the market clear 4100 on the upside (Friday’s close was 3934).

Last week, the market moved over 3% lower. The recent pattern has been for one 3% week to be followed by another. Thus, we expect a sizable move in the markets this week (either higher or lower depending on the results of the CPI data and Fed meeting).

The trend in 2023 earnings expectations remains lower. Currently, analysts are expecting a 5% decline in 2023 S&P 500 earnings year-over-year. In a significant recession, earnings would likely drop over 10%, so current analyst estimates may be too high.

Equity spin-offs can create alpha opportunities for discerning investors. Spin-offs have outperformed the S&P 500 index by 1.5% per year over the past 20 years.

Fixed Income Takeaways

Fixed income yields have risen significantly in 2023. General quotes as of Friday 12/9/22: Investment-Grade (IG) Corporate Bonds: 5.18% yield for the broad index. High-Yield Corporate Bonds: 8.61% yield for the broad index. Leveraged Loans: 11.78% yield for the broad index. Tax-Exempt Bonds: 3.26% for AA-rated municipals.

Last week’s Producer Price Index (PPI) inflation data came in slightly higher than expected, which caused a slight rise in yields. Government bond yields rose 7-10 basis points in the intermediate portion of the curve.

The Federal Reserve will likely raise interest rates once again this upcoming Wednesday, December 14. Expectations are for a 50 basis-point hike on the Fed Funds rate, to 4.50%. Such an action would mark a decline in the recent pace of rate increases but would still be a significant move.

Market participants will be keenly focused on the Fed’s outlook for 2023 during Chairman Jerome Powell’s speech on Wednesday.

The key variable to the 2023 outlook will be the debate between a Fed pause and a Fed pivot. In other words, once the Fed reaches the end of their rate hiking cycle, will they pause and keep rates high for an extended period? Or will they quickly pivot toward rate cuts? We believe the first scenario is more likely.

The Fed is expected to reach their terminal rate in May 2023, with the Fed Funds rate in the low 5% area. Significant rate cuts are priced into the forward curve beginning in late 2023.

Key Takeaways

Key’s 2023 Outlook in Brief: Was a pound of medicine worth an ounce of cure?

  • The Federal Reserve (Fed) used a heavy hammer in 2022 to slow inflation, yet when looking at certain closely watched indicators (e.g., CPI), the Fed’s actions have only had a modest effect.

  • Looking deeper and peering ahead, however, some economic pain has been inflicted and the inflation fever is slowly breaking in certain areas (housing, supply chains and prices on goods).

  • Other components of inflation are proving stickier (services and wages/labor).

  • Inflation will inevitably fall in 2023 but may not reach pre-COVID levels for some time, leaving the Fed little choice but to induce a recession to quell demand. The Fed’s long-term inflation target remains at 2%.

  • The labor market remains strong. Last Friday’s nonfarm payroll report showed that 263K jobs were added in November, vs. expectations of 200K. The labor market has shown persistent strength throughout 2022.

  • The Fed views the tight labor market as a source of services inflation (rising wages). In the post-COVID period, the US has experienced a persistent labor shortage.

Bottom line:

  • We expect a small recession sometime in 2023. The range of possible outcomes is wide. Asset prices will likely remain under pressure and volatile until the Fed shifts course.

  • New challenges lie ahead, such as a slowdown in corporate profits and declining consumer savings levels.

  • Equity markets will likely remain choppy. Investors should emphasize quality and stay selective.

  • Bonds are compelling for the first time in several years. Yields have increased significantly in 2022, improving the outlook for forward returns. However, credit trends require close monitoring and higher interest rates (which would put further pressure on bond prices) should not be ruled out.

  • New tools, such as alternative strategies and real assets, remain recommended where appropriate for increased diversification.

Equity Takeaways

Stocks fell in early Monday trading. The S&P 500 fell about 1%, while small caps fell almost 2%. International shares were mixed, but generally lower.

Recent equity market performance has mirrored typical performance around Thanksgiving periods. Stocks tend to drift higher during this time of the year. About two weeks from now, daily volume will dry up significantly.

Despite recent positive overall performance, underneath the surface of the market, we are not seeing signs of strong/breakout momentum. Only about 18% of Russell 3000 constituents were showing signs of momentum as of last Friday.

Typically, if a market were putting in a durable bottom, many more constituents would be showing breakout momentum. In this case, momentum is defined as an issue trading at a 20-day high.

S&P 500 earnings are likely to come under pressure in 2023. Market participants are aware that earnings are likely to fall in 2023 but are not pricing in a severe recession. The stock market is currently pricing in a soft landing for the economy.

Year-to-date (YTD) in 2022, we’ve seen a wide dispersion amongst equity returns. Longer-duration growth stocks have underperformed as interest rates have risen, as have higher-beta stocks. Value stocks have significantly outperformed the broader market.

The 3-month/10-year Treasury curve remains inverted. In a limited sample size of eight instances going back to 1969, forward equity returns have generally been positive after an inversion of this sort, albeit with significant outliers in 2000/2006.

Fixed Income Takeaways

Federal Reserve Chairman Jerome Powell gave a speech last Wednesday which was well received by investors.

Market participants liked Powell’s comment that increases in the Fed Funds rate will proceed at a slower pace in the future. However, Powell also stated that the Fed Funds rate will need to stay in restrictive territory for quite some time, a message that may have been overlooked by investors.

The top end of the current Fed Funds range is 4.0%, and the Fed has recently been raising rates in increments of 75 basis points. Based on Powell’s recent comments, it is likely that the Fed’s next rate hike will be 50 basis points in December. The Fed Funds rate is likely to peak around 5% in the first quarter of 2023, per treasury futures markets.

In Powell’s speech, he stated that the tight labor market is currently the largest source of inflation in the non-housing services area of the economy. The Fed will clearly be watching the labor market closely throughout 2023.

Floating-rate fixed income securities have outperformed fixed-rate securities in this year’s rising rate environment. Once the Fed Funds rate peaks, this dynamic may change, but we continue to see relative value in floating-rate securities and structured products.

Private debt has remained resilient in 2022 and can provide additional diversification within fixed income allocations. Defaults remain at near-record-low levels in both public and private credit markets. We will monitor the credit markets for increased defaults in 2023 as the economy slows.

Key Private Bank Investment Briefing Notes

Key Takeaways

Our Current Tactical Asset Allocation Recommendations (versus long-term strategic asset allocation targets):

Stocks: Neutral.

Bonds: Neutral (recently raised from underweight).

  • Once again, there is income in fixed income. As inflation cools, bonds can offer some support if earnings disappoint and the narrative shifts from a bond bear market to an earnings bear market.

  • Until recently turning neutral, we had been “underweight” fixed income in client portfolios for several years. This year, as interest rates rose quickly, high-quality bonds suffered one of their worst years on record.

  • Yields on all types of fixed income are now much more attractive. Bonds now project for higher forward returns than they did at this time in 2021. Additional methods of portfolio diversification are still needed, however, as noted below.

Cash: Neutral (recently reduced from overweight).

Alternatives: Still attractive for alpha generation.

  • Implementation varies by client. New portfolio tools are needed in a highly uncertain environment.

Real Assets: Still attractive for diversification purposes.

  • Most investors are underweight in nonfinancial assets outside of real estate.

Two Scenarios for a slowing economy in 2023 – Base Case/Bearish Case:

  1. Base case rationale – a mild recession (“softish” landing):

    • Corporate and consumer balance sheets are strong due to the post-COVID stimulus, and private sector debts have been extended at low interest rates.

    • High inflation boosts corporate top-line revenue growth, allowing companies to meet rising interest costs.

    • Recent banking reforms (post-2009 Great Financial Crisis) have significantly mitigated financial contagion risks.

    • Deglobalization and onshoring have led to increased infrastructure and defense spending.

  2. Bearish case rationale – a deeper/longer recession (“hard” landing):

    • Policymakers are constrained by high inflation. Interest rates will continue to rise, and rate cuts may not occur until much later than expected.

    • Balance sheets could deteriorate quickly – much of the world is still highly leveraged.

    • Monetary policy tightening is occurring at the fastest rate in the past 40 years.

    • A divided US government, while being viewed as favorable by many, is likely to limit fiscal support until after a recession has already begun.

    • Valuations on most asset classes are (were) high relative to historic averages.

    • Bottom line: the range of potential outcomes is larger than normal for 2023.

Equity Takeaways

After rising about 1.5% last week, stocks dipped in early Monday trading. The S&P 500 fell about 0.6%, while small caps fell about 0.9%. International shares were mixed on concerns of increasing COVID-19 cases in China.

Relative equity performance has shown wide dispersion in 2022. Compared to the S&P 500, Value stocks have outperformed by over 10% year-to-date (YTD), while Growth stocks have underperformed by over 10%. Small caps have outperformed the S&P 500 by about 3% YTD.

Developed international stocks have slightly outperformed US stocks YTD, while emerging market equities have lagged. However, the strong US dollar has been a headwind for US investors in foreign companies for most of 2022.

A key overhead resistance level for the S&P 500 remains at 4100. The index closed at 4026 last Friday. A break above the 4100 level would bode well for the end of 2022/ early 2023. We think it is more likely that the market will stumble as it approaches 4100.

Private equity funds are indeed more illiquid than public equity, as private equity managers require a stable capital base to execute their long-term plans. However, in some ways illiquidity can be an asset to investors. The illiquidity of private equity investments can help investors avoid behavioral mistakes by staying invested during market downturns. This week’s Key Questions article has more details on private equity.

Fixed Income Takeaways

Treasury yields fell slightly last week, with both the 2-year and 10-year note yields falling about 8 basis points. The 2-year/10-year Treasury curve was inverted by 78 basis points early on Monday. For context, 2-year yields were 4.47%, while 10-year notes yielded 3.69%.

A significantly inverted yield curve indicates several things. First, it indicates that market participants are expecting a slowdown in economic growth. Second, it shows that market participants expect the Federal Reserve (Fed) to begin cutting rates relatively soon (contrary to recent messaging from the Fed itself).

The minutes of the latest Fed meeting were released last week. Quoting: “a substantial majority of participants judged that a slowing in the pace of increases would soon be appropriate.”

The Fed is not talking about a pivot back to rate cuts; rather, a slowing in the pace of future rate increases. Market expectations are for the Fed Funds rate to rise to 5.00% in May/June of 2023, before falling to 4.50% by early 2024. The current Fed Funds rate is 4.00%.

Corporate credit performed well last week in conjunction with the rally in stock prices. BBB-rated bonds outperformed higher-rated credits, and spreads tightened about 5 basis points across the board. High-yield spreads also tightened, indicating an increased appetite for risk.

Key Takeaways

Our Current Tactical Asset Allocation Recommendations (versus long-term strategic asset allocation targets):

Stocks: Neutral.

Bonds: Neutral (recently raised from underweight).

  • Once again, there is income in fixed income. As inflation cools, bonds can offer some support if earnings disappoint and the narrative shifts from a bond bear market to an earnings bear market.

  • Until recently turning neutral, we had been “underweight” fixed income in client portfolios for several years. This year, as interest rates rose quickly, high-quality bonds suffered one of their worst years on record.

  • Yields on all types of fixed income are now much more attractive. Bonds now have greater potential for higher forward returns than they did at this time in 2021 and 2020. Additional methods of portfolio diversification are still needed, however – as noted below, stocks and bonds remain correlated with each other, meaning they may provide less diversification within a portfolio.

Cash: Neutral (recently reduced from overweight).

Alternatives: Still attractive for alpha generation.

  • Implementation varies by client. New portfolio tools are needed in a highly uncertain environment.

Real Assets:
Still attractive for diversification purposes.

  • Most investors are underweight nonfinancial assets outside of real estate.

Midterm Election Update:

Control of the House of Representatives has flipped to the Republicans, albeit with a very thin majority. The Senate will remain under Democratic control.

Gridlock is typically viewed as a positive by markets; however, the current situation could present its own challenges. In general, we expect less fiscal support, more oversight (crypto, China, big tech) and a political battle over the debt ceiling next spring.

Equity Takeaways

Stocks dipped slightly in early Monday trading. The S&P 500 fell about 0.4%, with small caps down a similar amount. International shares were also lower.

The S&P 500 remains in a year-long downtrend channel. The recent rally has taken the S&P 500 toward the top end of this range, near 4100. Last week’s price action saw the market pull back at this resistance level – discouraging price action for the bulls.

The week of Thanksgiving tends to have a positive seasonal tailwind, as do the weeks around the Christmas holiday. Price action for the remainder of 2022 will give some clues as to the underlying health of the market as we move toward 2023.

The American Association of Individual Investors (AAII) releases a weekly investor sentiment survey. Over the past year, every time bullish sentiment in this indicator rose to 32%, the stock market experienced a short-term peak.

Last week, AAII bullish sentiment once again reached 32%, implying that individual investors are becoming more bullish. Recall that bearish sentiment is a tailwind for the market (and vice versa) – the more bearish investors are, the more selling has already taken place.

The US dollar peaked and reversed sharply lower over the past six weeks. US dollar strength is a headwind for corporate profits for US multinational companies; thus, a strong dollar can also be a negative for the stock market. A weakening dollar could be especially beneficial to cyclical sectors (industrials, materials, semiconductors), as well as commodities.

Oil prices have fallen about 10% over the past three weeks on concerns over the strength of the global economy, especially China which has been hampered by its “zero-Covid” policy. Front-month futures spreads went into contango (the current oil contract is trading at a discount to the second month) for the first time since 2021.

Indications are that demand for petroleum is falling faster than OPEC+ production cuts. Contango in the oil market usually occurs when supply is rising faster than demand.

Due to a combination of high storage and higher-than-expected temperatures, European energy prices have fallen sharply in recent months. That said, prices are about twice as high as they were prior to the recent crisis.

Fixed Income Takeaways

The 2-year/10-year Treasury curve inversion reached 71 basis points last week, its largest inversion since the early 1980s. In early Monday trading, the 3-month T-bill yielded about 4.25%, while the 10-year Treasury yielded about 3.80%.

Recent Federal Reserve speakers maintained a hawkish tone despite several recent reports that indicated inflation could be slowing. Federal Reserve Governor James Bullard went as far as to suggest that the Fed Funds rate would need to be raised as high as near 5.00% to 7.00% (versus its current level of 4.00%). Market expectations of future rate increases rose after his comments.

The shape of the Treasury and Fed Funds futures curves indicate a terminal Fed Funds rate above 5.00%. Market participants are pricing in continued sharp near-term tightening, followed by an economic slowdown/recession and subsequent rate cuts.

Despite the potential for a recession next year, credit markets remain well-behaved, with spreads showing limited signs of stress. The ICE BofA BBB-rated corporate bond index is currently trading with a spread of 182 basis points to Treasuries. For context, this index peaked with a spread of 788 basis points during the 2008 Great Financial Crisis.

Key Takeaways

Our Current Recommendations (versus long-term strategic asset allocation targets):

Stocks: Neutral.

Bonds: Neutral (recently raised from underweight).

  • Once again, there is income in fixed income. As inflation cools, bonds can offer some support if earnings disappoint and the narrative shifts from a bond bear market to an earnings bear market.

Cash: Neutral (recently reduced from overweight; allocate to bonds).

Alternatives: Still attractive for alpha generation.

  • Implementation varies by client. New portfolio tools are needed in a highly uncertain environment.

Real Assets: Still attractive for diversification purposes.

  • Most investors are underweight in nonfinancial assets outside of real estate.

Election Results:

  • The red wave broke early, and a purple swirl emerged. The Democrats outperformed expectations by maintaining control of the Senate. Republicans seem likely to take control of the House by a narrow margin.

  • Next year, investors should expect less fiscal support, more oversight, more gridlock and more confusion for the Federal Reserve (Republicans want inflation to be the focus, while Democrats want the focus to be maximizing employment).

  • Gridlock is generally good for the markets. That said, the debt ceiling will be up for reapproval next spring which could be a source of volatility once again.

Inflation and Economic Update:

  • Last week, the Consumer Price Index (CPI) surprised to the downside. After this cooler-than-expected report on inflation, the stock and bond markets both rallied sharply. Market participants immediately priced in a lower terminal Federal Funds Rate, which supported the sharp rally in risky assets.

  • Key advises caution in extrapolating one month of data far into the future. While last week’s CPI report was a welcome sign, inflation, while falling, is likely to remain elevated for quite some time.

  • It is not likely that the Federal Reserve (Fed) will change its current restrictive policy stance based on one month of data.

Cryptocurrency Update:

  • FTX, one of the top-three cryptocurrency exchanges in the world, filed for bankruptcy last week.

  • Effectively, the exchange experienced a classic “run on the bank,” whereby FTX did not have sufficient liquidity to meet about $8 billion in customer withdrawal requests.

  • Many institutional investors used FTX as a custody platform, so we could see some contagion and/or short-term pressure on risky assets and cryptocurrency prices.

  • Key does not have direct exposure to FTX through any of our recommended investments, and we have historically been cautious about cryptocurrencies (but intrigued by Blockchain). We will continue to monitor the situation.

Equity Takeaways

Stocks fell slightly in early Monday trading. The S&P 500 dropped about 0.2%, while small caps fell about 0.4%. International shares were mixed.

The end of last week saw a sharp rally that was touched off by Thursday morning’s CPI report, which showed lower-than-expected inflation for October. The S&P 500 rallied over 5% on Thursday and closed the week about 6% higher. The tech-heavy Nasdaq fared even better, rallying over 7% on Thursday before closing the week over 8% higher.

Going into last Thursday’s CPI report, the bears had been in control of the market. The favorable inflation data allowed bulls to go on the attack once again. Advancers outnumbered decliners by 11:1 during last Thursday’s sharp rally.

Liquidity remains poor. We are in a reactionary market, not a forecasting market. In a bear market environment, rallies tend to be very sharp as the market reacts to every new piece of data.

The stock market likes to inflict the maximum amount of pain possible. Sentiment and positioning can dominate short-term trading patterns, especially in a low-liquidity environment. Heading into last week’s CPI report, sentiment was negative and thus when inflation was slightly below forecast, bearish trades had to be unwound which further propelled the rally in equities.

Over two days last week, the US dollar fell about 4%, a sharp move for a currency. This year’s very strong dollar has been a headwind to corporate profits for US multi-nationals. Combined with falling Treasury yields, a falling dollar could be a short-term tailwind for equities into year-end.

Corporate earnings forecasts for 2023 continue to trend lower. Over the next six weeks or so, positive seasonal patterns could support the market, but if earnings estimates continue to move lower, it will be tough for the market to mount a sustained rally into 2023.

Fixed Income Takeaways

Treasury yields plunged across the curve last week, led by the 5-year note. 5-year Treasury note yields fell 31 basis points in a single day alone after last week’s CPI print. Overall, 5-year yields fell 39 basis points last week.

After last week’s sharp market moves, 14 Federal Reserve members will be making speeches this week. It is likely that these Fed governors will stick to their recent message of controlling inflation via restrictive monetary policy.

The 3-month/10-year Treasury curve inverted in recent weeks, following curves such as the 2-year/10-year Treasury. The inversion of the 3-month/10-year Treasury curve tends to be a timelier harbinger for a recession than the 2-year/10-year curve.

Investment-grade (IG) bond spreads tightened 2-6 basis points last week. New issuance activity was much heavier than expected, as corporations took advantage of lower all-in yields.

High-yield bond spreads widened slightly last week with BB-rated paper outperforming weaker-rated issues.

Key Takeaways

  1. New Key Tactical Asset Allocation recommendations (versus a client’s long-term strategic asset allocation and investment objective target):

    Stocks: Neutral (no change).

    Bonds: Neutral (change from De-Emphasize).

    • There is income in fixed income again. In addition, as inflation cools, bonds can offer some support to portfolios if earnings disappoint and recession risks continue to rise.

    • For example, one year ago, the core aggregate bond index was yielding 1.68%. Today, the yield on that index of high-quality bonds is about 5%.

    Cash: Neutral (from Emphasize). Use previous higher cash allocation recommendation to now purchase bonds.

    Alternatives and Real Assets: Continue to emphasize where appropriate (no change).

    • Stocks and bonds have once again become correlated. New diversification tools are needed in a highly uncertain environment, and thus alternative/ real asset strategies may be beneficial for some clients, but selectivity is important.

  2. Current Economic Environment:

    • Today’s environment of high inflation and low unemployment is in many ways unprecedented. Employment trends are cooling, but very slowly.

    • Technology companies have been large job creators. Layoffs in the technology sector have begun to increase, which could eventually put some downward pressure on wage inflation, all else equal.

    • The Federal Reserve remains primarily focused on trying to cool inflation and will likely continue with hawkish monetary policy into 2023. That said, the pace of rate increases is likely to slow as we move into 2023.

Equity Takeaways

Stocks were slightly higher in early Monday trading. The S&P 500 rose about 0.20%, with small caps rising a similar amount. After rising sharply last Friday, international shares were mixed.

Within our recommended equity allocation, Key is now recommending a slight increase in our weighting towards US small and mid-cap stocks than previously recommended, relative to large-cap stocks. Due to the uncertain forward outlook, we are also recommending a tilt towards defensive equity sectors (consumer staples, etc.) within portfolios.

Both small and mid-caps are historically cheap versus large caps on both an absolute and relative basis. Small caps are generally more cyclical (more exposed to recession). However, small caps are also less exposed to weakness overseas.

S&P 500 forward earnings estimates have begun to fall but could fall further if a recession were to materialize. Typically, earnings fall about 15% during a recession. The stock market has already dropped significantly in 2022, but it is unclear how much earnings weakness is already priced in.

Fixed Income Takeaways

Last week’s Federal Reserve (Fed) Meeting Key Takeaways:

  • In a move that was expected, the Fed increased interest rates by another 75 basis points to 4.00% (upper limit of the range).

  • Going forward, the pace of rate hikes may slow, but the Fed is not done yet.

  • During his press conference after the Fed’s policy announcement, Fed Chairman Powell stated that his preference would be to over-tighten rather than under-tighten. In other words, the Fed is still focused on bringing inflation down to its long-term target of 2.0%.

  • The terminal Fed Funds rate is likely to peak at over 5.00%, which would be considered a restrictive policy stance. Even if the future pace of rate increases were to slow, this terminal rate is higher than market expectations of just several months ago. At this point, it’s more about the destination (the terminal rate) than the journey (pace of rate increases).

  • A direct quote from the Federal Reserve statement: “… incoming data since our last meeting suggest that the ultimate level of interest rates will be higher than previously expected.”


Key Private Bank Investment Briefing Notes

Key Takeaways

  1. Is the acceleration in inflation over?

    • Inflation is cooling, but the economy is still too strong, and the labor market is still too tight for the Fed to ease off the brakes.

    • The Federal Reserve’s favored measure of inflation is the Personal Consumption Expenditures (PCE) Index. While last Friday’s Personal Income and Outlays report from the Bureau of Economic Analysis showed that year-over-year PCE inflation cooled slightly, it remains elevated at 6.2%.

    • Other forward measures of inflation are slowing more quickly. The NY Federal Reserve’s Global Supply Chain Pressure Index continues to fall. Other measures, such as Purchasing Manager Index (PMI) output prices, rent growth, and the M2 money supply, are all slowing.

  2. Is the recession over?

    • The US economy rebounded in the third quarter of 2022. Trade flows, which were a strong drag on the economy in the first quarter, have reversed and provided a tailwind in Q3. Consumer spending also remained relatively strong but grew at a slower pace relative to the prior quarter.

    • The recession has not yet begun. The forward outlook for the economy and inflation is more important than what happened in the recent past, and we are seeing evidence that the outlook for 2023 is growing cloudier.

  3. Is the peak in Federal Reserve (Fed) policy tightening over?

    • Possibly, but a “step down” to a more neutral policy is not the same as a “pivot” to dovish policy and/or rate cuts.

    • Financial conditions may be tightening too much: Fed tightening (interest rate increases) + higher mortgage rates + quantitative tightening (Fed balance sheet reduction, or “QT”).

    • Tighter financial conditions risk causing too much damage and a cautious stance in portfolios remains warranted.

    • Going back to WWII, the average Fed hiking cycle has lasted two years and resulted in an average trough-to-peak hike of about 4.0%. Rate hikes act with a lag and can take several quarters to impact inflation and unemployment.

* Bottom line:

  • Volatility will likely persist until inflation clearly peaks and over-hang from the Fed lifts. Seek relative pockets of refuge and opportunity. Focus on what you can control. Consider tax-loss harvesting as well as additional diversification in the form of alternatives.

  • Equities: prefer equal-weight indices versus market-cap-weight indices (see below for details).

  • Bonds: neutral and/or short duration. Focus on high-quality credit (both taxable and tax-exempt).

  • Alternatives: absolute return, low volatility, macro/ trend-following, and private credit.

Equity Takeaways

After a strong week that saw the S&P 500 rise almost 4%, US stocks opened lower on Monday (Halloween). The S&P 500 fell about 0.8%, while small caps fell about 0.5%. International stocks also fell.

The first three weeks of November tend to be the best three weeks of the year for stocks. Recently, the US dollar has weakened, and US Treasury rates have dropped. Both have been tailwinds for stocks over the last several weeks.

If credit spreads were to tighten over the next few weeks, we could see the recent rally continue toward the 4,000 to 4,100 area. The S&P 500 closed last Friday at 3901.

After a late October rally, the S&P 500 was down about 17% year-to-date (YTD) through 10/28/22. YTD, value stocks have significantly outperformed growth stocks. In addition, US stocks have outperformed international stocks.

Key Private Bank continues to emphasize equal-weight index exposure versus market-capitalization weighted indices in client portfolios. Practically speaking, equal-weight indexes are underweight technology and overweight sectors like industrials and financials.

As we move into 2023, Key Private Bank will recommend adding a modest amount of additional small cap exposure to client portfolios. Small cap stocks tend to be domiciled in the US. In addition, small caps are inexpensive on both an absolute basis, and on a relative basis compared to large cap stocks.

Fixed Income Takeaways

The Federal Reserve is expected to raise rates by another 75 basis points this week, to 4.00%. That said, market participants are once again anticipating a slowing or pause in rate hikes early in 2023. During this week’s press conference, most attention will be focused on Fed Chairman Powell’s comments regarding the forward outlook for Fed policy.

Treasury yields fell last week as market participants have begun to anticipate less aggressive Fed policy in early 2023. 10-year Treasury yields fell about 20 basis points last week, while 2-year Treasury yields fell about 6 basis points.

The 3-month / 10-year Treasury curve briefly inverted last week. An inversion in this curve has traditionally been a harbinger of recession. 3-month T-Bills yielded about 4.00% in early Monday trading, while 10-year T-Notes yielded about 4.05%.

There is income in fixed income again. Bond yields have broken out to multi-year highs. Treasuries are yielding 4% or above across the curve, while BBB-rated corporate bonds now generally yield above 6%. For this reason, if clients are sitting on excess cash, it likely makes sense to begin adding to fixed income once again.

Investment-grade (IG) corporate bond issuance picked up last week, to the tune of $35B. Calmer market conditions allowed for increased new issuance.

Key Takeaways

  1. Inflation is cooling, but the economy and the labor market are both too strong.

    • Inflation is likely to slow sharply at first but is likely to stabilize at a level higher than pre-COVID levels.

    • Freight rates, used vehicle prices, retailer pricing power survey data and even rent survey data are all slowing.

    • M2 money supply growth rate has dropped to 1.4%, from peak growth rates above 25% year-over-year during the COVID-19 crisis. If M2 growth dips into negative territory, it would be the first such occurrence since the 1930s.

    • The housing market is likely entering a recession due to sharply rising mortgage rates. However, the overall industrial economy remains very strong. Overall industrial production broke to a new high recently, and capacity utilization is above 80%, a robust level.

    • The Atlanta Fed GDPNow estimate for third quarter 2022 real GDP rose to near 3% last week, which would be an acceleration in growth from the first half of 2022.

    • The labor market remains very tight, a situation which continues to put upward pressure on inflation. Continuing unemployment claims have not increased in over six months, suggesting that unemployed individuals are having little difficulty finding work.

  2. Financial conditions may be tightening too much.

    • The Federal Reserve’s balance sheet has dropped by $1.2T during 2022, to its current level of about $8.7T of total assets. Liquidity is being drained from the system.

    • Tightening liquidity can be seen in Treasury market volatility, currency market volatility, widening credit spreads, etc.

  3. Tighter financial conditions may be causing too much damage to financial markets, liquidity, currencies, household debt and household net worth.

    • Last Friday, a Wall Street Journal article suggested that some Federal Reserve (Fed) governors are beginning to worry about the effect of tightening financial conditions, versus a recent singular focus on controlling inflation. The stock market rallied on this news.

    • The current situation could be analogous to the mid- to late-1940s, which saw a choppy digestion period after a large post-WWII consumer boom.

  4. Volatility will likely persist until the overhang from an aggressive Federal Reserve lifts.

    • Seek relative pockets of refuge and opportunity.

    • Equities: Emphasize equal-weight indices versus market-cap-weighted indices (de-emphasize mega tech and/or growth and emphasize midcap and/or value).

    • Bonds: Stay neutral and/or short duration; emphasize high-quality credit (taxable and tax-exempt).

    • Alternatives: Absolute return and/or low volatility strategies; macro/trend-following strategies and private credit strategies.

    • Other: Focus on what you can control, such as tax-loss harvesting strategies. Stay diversified and consider some of the new tools mentioned above.

Equity Takeaways

Early Monday trading in stocks was choppy. Initially, stocks rose about 1%, continuing the momentum from last Friday, before pulling back.

International shares were mixed. European shares rose slightly, while emerging market stocks fell sharply, led by weakness in China. Chinese shares fell on news that Xi Jinping has further secured his power and embarked on a third term as leader. Markets in Hong Kong were hit particularly hard on this news.

The S&P 500 remains choppy and has now moved at least 1% in the previous 10 consecutive weeks. Last week, the chop was to the upside, as the S&P 500 rose about 4.7% on the week. The S&P 500 rallied about 2.4% on Friday alone, bolstered by the Wall Street Journal article referenced above.

Some very large companies are reporting this week – eight companies that comprise about 24% of the S&P 500’s market capitalization. The market’s reaction to these reports will be very important. Energy remains the clear market leadership sector.

This earnings season, companies that beat earnings and revenue expectations are not being rewarded very much (up a little over 1%). On the other hand, companies that miss on earnings and revenue estimates are being punished (down over 6%). In other words, misses are being penalized much more than beats are being rewarded.

Fixed Income Takeaways

Last week, the Treasury curve steepened. 2-year note yields dropped about 2 basis points, to 4.47%, while 10-year Treasury yields rose 20 basis points, to a new cycle high of 4.22%.

The drop in 2-year Treasury yields was likely caused by the Wall Street Journal article referenced above, which suggested that some Federal Reserve governors would like to pause the current aggressive rate hiking cycle early in 2023. 2-year yields are very sensitive to Fed policy expectations.

For example, Fed Governor James Bullard suggested that the Fed should hike twice more in 2022, by 75 basis points each, before pausing. The current Fed Funds rate is 3.25%.

Last week, investment-grade (IG) corporate spreads widened by one basis point, to 171 basis points (bps). About $20B of IG paper priced on the week. Overall, new issuance for the month of October has been well below expectations, a dynamic which is likely supporting spreads.

High-yield spreads to Treasuries, while elevated, are well below levels that would indicate severe stress. The corporate default rate remains very low, at about 1.5%. Back during the 2008-2009 Great Financial Crisis, the corporate default rate reached 14-15%.

The weakest high-yield bond market is in China, which has been dragged down by stress in the Chinese real estate market. Within the US, the lowest-rated issues (CCC) have performed the worst. Floating-rate securities (levered loans and structured products) have performed the best.

High-yield bonds tend to have a lower duration (less sensitivity to rising interest rates) than investment-grade bonds, a fact that has also supported relative performance.

Key Takeaways

  1. Three “Cs” define today’s perfect storm – Consumers, Currency and China – all are causing consternation. Volatility has increased, and valuations are re-rating lower.

    • Consumer Price Index (CPI), and consumers’ inflation expectations: last week’s CPI report indicated continued high inflation. Long-term consumer inflation expectations also increased slightly.
      • Housing inflation should begin slowing soon (tends to follow home prices with a lag). Other indicators, such as bank deposits and freight prices, also suggest inflation should begin moderating going forward.
    • Currencies’ impact on earnings: the US dollar remains very strong and has been a headwind for US multinational companies that earn significant revenue outside the US.
    • China: Xi Jinping remains focused on keeping the Party in power, and himself as its leader, at all costs.

  2. Three additional “Cs” to watch.

    • Credit, COVID and Crises. As the saying goes, the Federal Reserve (Fed) usually tightens until something breaks.

  3. Contrary to what you hear on television, investment values and opportunities are emerging amidst the volatility.

    • Lots of bad news is already priced into the markets. The markets have already anticipated a slowdown in earnings and/or a recession, neither of which has yet occurred. Typically, the market falls in tandem with declining earnings.

  4. Volatility will likely persist until the overhang from the Fed lifts. Seek relative pockets of refuge and opportunity.

    • Equities: favor equal-weight indexing versus market-capitalization-weight indexing. Equal-weight indices de-emphasize mega-cap technology/growth stocks and emphasize mid-cap/value stocks.
    • Bonds: stay neutral and/or short duration. Focus on high-quality issuers (both taxable and tax-exempt).
    • Alternatives: absolute return, low volatility, macro/ trend followers and private credit strategies all look interesting. Hedge funds have generally had a successful year on a relative basis.

Equity Takeaways

US equity markets opened sharply higher on Monday. The S&P 500 rose over 2% in early trading, with small caps rising a similar amount. International shares also rose sharply.

Last week was the ninth straight weekly move of at least 1%, with the S&P 500 declining about 1.5%. This type of price action has only occurred 10 other times in the past. During this streak, the market has advanced on a weekly basis only two out of nine times, indicating continued weakness.

This year, many types of historical patterns are not working. For example, the significant breadth thrusts that we saw over the summer did not hold. The market failed lower, rendering those signals invalid.

In short, caution remains warranted until the market begins showing signs of a more stable bottom. Price trumps all.

Credit spreads remain important to watch and could give important clues on when the stock market is ready to turn higher. Recently, the spread between the riskiest types of corporate issuers has widened (CCC-rated less B-rated). When this spread widens, the market is usually under stress.

Fixed Income Takeaways

Treasury yields rose across the curve last week in reaction to last Thursday’s CPI report, which showed continued hot inflation. 2-year Treasury yields moved above 4.50%, while 10-year Treasury yields crested 4.00%, before moving slightly lower in early Monday trading.

Municipal bonds, on the other hand, remained relatively flat in yield last week. During times when the Treasury curve inverts, the municipal bond market typically remains flat due to strong client demand for short-duration Municipals.

As a result, Municipals are once again becoming more expensive relative to Treasuries. Currently, on the front end of the curve (inside 10 years), Municipals are at a fair value relative to Treasuries.

In 2022, significant outflows have hit the municipal bond sector. Forty (40) consecutive weeks of outflows have resulted in a very long outflow cycle totaling a cumulative $100B. Typically, once the 10-year yield peaks, about four to six weeks afterwards, you will see inflows return to the municipal bond market.

Municipal bond spreads have widened somewhat during the recent market volatility but remain slightly more narrow than historical averages. As with taxable bonds, the municipal markets are under pressure but are not showing signs of panic.

Key Takeaways

  1. Another tough month for asset prices makes for another very tough year, especially in the bond market.

    • The S&P 500 dropped 9.2% in September and has dropped 23.9% year-to-date (YTD).
    • Core bonds fell almost 4% in September and have dropped about 14% YTD – this is the worst YTD performance on record for high-quality bonds.

  2. Recap: supply and demand are out of balance.

    • Too much money (demand) is chasing too few goods, especially in the United States.
    • In addition, the supply of labor remains challenged, limiting overall output.

  3. Looking ahead: inflation should fall but the relationship between labor and profits remains challenging for the economy.

    • 1-year break-even inflation rates (one measure of forward inflation expectations) peaked at 6.2% in March 2022 and have recently fallen to 1.7%.
    • M2 money supply growth peaked at close to 30% year-over-year in 2020 – this metric recently dropped to 2.8% year-over-year as of September 30, 2022.
    • Housing prices are feeling the effects of higher mortgage rates – in August 2022, home prices fell the most in a decade according to Bloomberg.

  4. More immediately – has the US Federal Reserve (Fed) already broken something?

    • If so, negative ramifications may persist in the short run (in the form of contagion). For example, the MOVE index (a measure of bond market volatility) has risen back to levels last seen in March 2020.
    • Bullish ramifications may emerge in the long run – the Fed may be forced to pivot towards easier monetary policy.
    • That said, with inflation stubbornly high, central banks are in a near-impossible position. The global economy is likely to weaken further before a pivot occurs.

  5. The financial system in the United Kingdom (UK) has come under severe stress.

    • Touched off by budgetary concerns, the British pound has weakened significantly versus the US dollar over the past 10 days, and UK bond yields (aka gilts) have spiked higher. The Bank of England was forced to respond by purchasing gilts to help control yields.
    • Going forward, this episode indicates that budget deficits will begin to matter again. Contagion risks are not immaterial, but we don’t believe the current situation is a precursor to another Great Financial Crisis.
    • The US is still in an advantageous position as the world’s reserve currency but is not fully immune from international affairs.

  6. Bottom line: expect short-term volatility to continue – stay focused on your long-term financial plan.

    • Sentiment remains very bearish – poor sentiment is not a timing indicator but does indicate that a lot of bad news is already priced in.
    • We remain optimistic on human ingenuity, which has continually driven long-term economic growth.
    • Finally, as noted below, historical seasonal patterns in the stock market will turn positive in mid-October.

Equity Takeaways

After another tough week that saw the S&P 500 fall another 2.9%, stocks attempted a rally in early Monday trading. The S&P 500 rose about 1%, with small caps up a similar amount. International shares also rose.

September 2022 was the ninth worst September on record for the S&P 500. September is typically one of the worst calendar months of the year.

Seasonal stock market trends will typically bottom in mid-October. Traditionally, the best part of the calendar year is mid-October until the end of the year (especially during a midterm election year), but other factors may dominate this year.

Despite favorable seasonal trends approaching, the Credit spreads also widened significantly last week and are now wider than levels seen during the June lows in the stock market. This spread widening likely portends further stock market weakness.

If the June lows in the S&P 500 fail (as now seems likely), the next support level should emerge around 3400 on the S&P 500. In early Monday trading, the S&P 500 was trading around 3620 (very close to the intraday lows seen in June).

The spread between the 3-month and 1-month implied volatility index typically widens to -3 or -4 during a bout of severe volatility. Recently, that index went negative, but only to about -1, which indicates that fear in the marketplace has not yet peaked.

Fixed Income Takeaways

Treasury yields continue to surge higher across the curve. 10-year Treasury yields briefly touched 4.00% last week, before closing the week at about 3.80%. It was the ninth consecutive week of higher 10-year note yields.

Long-dated UK gilt yields surged almost 150 basis points (bps) last week. The Bank of England was forced to step in to stabilize the market by announcing an unlimited open- ended purchase program.

Central banks around the world remain intent on raising rates. The Bank of England is expected to raise rates about 120 bps by early November, while the US Federal Reserve is expected to raise rates by another 75 bps in November. The US Fed Funds rate is expected to close the year well above 4.00% (from its current level of 3.25%).

Investment-grade (IG) bond spreads widened by 16 bps during last week’s risk-off tone. All-in yields on the IG index are approximately 5.70% – both Treasury yields and credit spreads were higher on the week.

A very small amount of new debt priced last week – expectations were for about $15B-$20B of new IG issuance, but we only saw about $1.2B price. Typically, September is a busy month for new issuance, but this past month was quiet due to high market volatility.

Key Takeaways

  1. The US Federal Reserve (Fed) has sent a clear message – while neither is preferable, a recession is preferred over high inflation.

    • There is now an above-average chance that the Fed will over-tighten monetary policy.
    • Currently, the Fed is executing its fastest tightening cycle ever.

  2. The Fed’s projections have been notoriously inaccurate, and they have pivoted in past cycles.

    • That said, a near-term pivot towards a looser monetary policy is highly unlikely. Moreover, today’s environment is highly unique, in that unemployment has remained very low even as inflation has risen.
    • Recent comments from the Fed indicate that they plan on raising interest rates into 2023. The current Fed Funds rate is 3.25% (upper limit of the target range). The terminal Fed Funds rate is now projected to peak between 4.50% and 5.00%, well above projections from even several months ago.

  3. Inflation should start moderating soon.

    • M2 money supply growth has dropped to about 3% year-over-year. At one point after the COVID-19 crisis, M2 money supply growth was over 30% year-over-year.
    • Employment trends will be important to watch, as these are among the indicators that are followed most closely by the Fed.

  4. Equity investors remain very pessimistic.

    • Fixed income investors have driven up yields to more realistic levels versus inflation.
    • Alternatives, such as hedge funds, have held up relatively well this year. Our internally managed strategies, both liquid and illiquid, have significantly outperformed other asset classes.
    • The midterm elections in November could provide a catalyst, but the market is likely to remain volatile over the near term. Stay neutral on equities versus strategic long-term targets and continue to remain focused on your long-term financial plan.

Equity Takeaways

US large-cap stocks wobbled from slightly negative to slightly positive in early Monday trading, while small caps rose slightly. International shares were generally lower.

Context is important. Despite a very tough 2022 in which the S&P 500 has fallen about 23% year-to-date (YTD), long-term returns remain favorable. For example, through 9/23/22, the S&P 500 had risen 13% over the prior two years, 29% over the prior three years, and 51% over the prior five years.

Corporate earnings growth is looking more suspect, even as the stock market gets cheaper relative to expected earnings. Cheaper valuations are an insufficient catalyst for markets to bottom.

Indeed, S&P 500 earnings are expected to grow about 8% in 2023. In a potential recessionary scenario, these estimates seem overly optimistic.

The implied volatility index (VIX) has remained relatively contained during the recent selloff. In early Monday trading, the VIX traded around 31.0. Typically, readings above 36.0 can help mark interim bottoms due to extreme pessimism and/or fear.

Fixed Income Takeaways

Yields moved much higher across the yield curve last week, as the Fed indicated it would raise rates by another 125 basis points (bps) by year-end.

As a result, 2-year Treasury yields moved 35 bps higher last week, to close at 4.20%. 5-year yields also jumped 35 bps, to almost 4%. 10-year yields jumped 24 bps, to close the week at 3.69%.

The 2-year Treasury note yield closed last week 51 bps higher than the 10-year yield, which is the largest inversion since 1982. This type of deep inversion implies that market participants are expecting an imminent economic slowdown.

The only yield curve that is not currently inverted is the 3-month/10-year curve. 3-month Treasury bills currently yield about 3.20%.

After Fed Chairman Jerome Powell’s August speech, and the subsequent Federal Reserve meeting last week, market participants are not expecting a Fed pivot until 2024 at the earliest. In short, significantly tighter forward Fed policy has been priced in over the past month.

Credit spreads remain elevated, but not panicked. All-in corporate bond yields are looking more and more attractive. BBB-rated corporate bonds are yielding approximately 5.75% (versus 2.30% a year ago), while the high-yield corporate bond index stands at 8.84% (versus 4.05% a year ago).

Investment-grade (IG) spreads widened 6 bps last week, while high-yield spreads widened about 12 bps. Spread widening has been most pronounced in the weakest credits. Only $6 billion of new IG issuance was priced last week, versus expectations of $35 billion, due to rising all-in yields.

Key Takeaways

  1. Stock prices are again perched at important levels (S&P 500 is down about 18% year-to-date).

    • Many indices, such as the Nasdaq 100, are down well over 20% year-to-date.

  2. Problematically, GDP growth and earnings forecasts are falling, while inflation is still rising.

    • The Atlanta Federal Reserve’s GDPNow model for Q3:2022 GDP growth has been revised lower several times over the past few weeks and is now just slightly positive. The model’s decline stems from a drop in personal consumption.
    • In aggregate, analyst estimates for Q3:2022 earnings see S&P 500 earnings growth of 3.5%, down over 600 basis points versus three months ago. In addition, seven of 11 sectors are poised to see year-over-year earnings declines in Q3.

  3. Some forward inflation indicators are easing, while others are accelerating.

    • Core inflation (heavily influenced by shelter prices) continued to increase in August, while headline inflation declined (led by lower energy prices).
    • On the other hand, recent survey data on rents, small business pricing power, and consumer inflation expectations all point towards easing inflation in the future.
    • Bottom line: the Federal Reserve (Fed) is likely to continue its tightening policy in the coming months, and recent comments from various Fed governors indicate that policy could remain restrictive for some time.

  4. Equity investors remain pessimistic about future returns (sentiment remains negative).

    • Bond investors are becoming more realistic about future Fed policy, pushing yields higher. Several months ago, rate cuts were expected in early-mid 2023, but that is no longer the case.
    • The November midterm elections could be a catalyst. Markets are likely to remain choppy over the near term, but negative stock market sentiment does indicate that a lot of bad news has already been priced into the market. The typical historical pattern is for US equities to rise after the midterm elections.

  5. Correlations among asset classes remain high.

    • Investment-grade corporate bonds are down about the same as US stocks, at -18% year-to-date (YTD). We continue to recommend additional diversification into alternative investments and real assets.
    • History suggests patience will be required, but we are optimists over the long run for human ingenuity. We have been emboldened by tangible signs of generosity and people wanting to do good.

Equity Takeaways

US stocks opened slightly lower in early Monday trading. The S&P 500 fell about 0.4%, while small caps were essentially flat. International shares were also lower.

For the first time in history, more assets are managed in passive index-tracking strategies than actively managed strategies. The S&P 500 is now the most-owned financial asset in the world. Interestingly, this increased ownership of the S&P 500 has led to higher realized volatility versus other types of stocks (such as small caps) during periods of stress.

A greater number of actively managed mutual funds are performing better than the index benchmark so far this year, relative to historical track records.

Institutional investors continue to increase their allocation to private investments (private equity/debt, private real estate and hedge funds).

Fixed Income Takeaways

A hotter-than-expected Consumer Price Index (CPI) reading last week caused yields to rise across the Treasury curve. For example, 2-year Treasury yields jumped 28 basis points (bps) last week, to close Friday at 3.85%; 10-year yields jumped 13 bps last week, to close Friday at 3.45%.

Treasury yields are moving higher again in early Monday trading. This week, the Fed is expected to raise the Fed Funds rate by at least 75 bps, to a range of 3.00% to 3.25%. A 100-bps rate hike is not off the table (about a 20% chance according to market participants).

One reason the Fed may stick with a 75 basis-point hike this week instead of 100 bps is the fact that the Fed’s preferred inflation indicator, Core Personal Consumption Expenditures (PCE), peaked in February and has been slowly moving lower. The next round of PCE data will be released on September 30.

High-quality credit held up well during last week’s move higher in Treasury yields. In general, investment-grade (IG) spreads were slightly tighter. Higher-quality credits outperformed, in part due to a slowdown in new IG issuance. Issuance was heavy last Monday but declined sharply after the CPI release last Tuesday.

Conversely, high-yield credit spreads widened last week, led by the weakest issuers (CCC-rated). The broad high- yield index widened by 43 bps.

Key Takeaways

The US Dollar remains one of 2022’s most compelling themes. The spot US dollar index has moved about 15% higher year-to-date, which is a very large intra-year move in the currency world.

While it is possible that the dollar uptrend could pause over the short term (and we have seen some weakness over the past few sessions), it seems likely that long-term dollar strength will continue.

The Japanese Central Bank continues to maintain an easy money policy. As a result, the Japanese Yen has weakened significantly versus global currencies and seems likely to weaken further. We do not see any immediate impact to US-based investors but will continue monitoring for any second-order effects.

Japan is unusual in that most global central banks have increased interest rates significantly in 2022, while Japan has kept rates low. China is the only other major economic power that has not increased interest rates significantly this year.

The current $85 level is a battleground for crude oil. Further weakness in crude oil prices could foreshadow global economic weakness. In a recessionary scenario, crude could fall into the $60 to $75 range.

We have spoken with several commodity fund managers recently, and according to these managers, there is a significant supply/demand imbalance in the crude oil markets. Even a modest recession in the US might not derail the bullish case for long-term oil prices. A similar supply/demand imbalance exists in the agriculture markets.

Equity Takeaways

US stocks rose in early trading on Monday. The S&P 500 rose about 0.5%, with small caps up a similar amount. A possible deal in Europe over the weekend to help control energy prices supported European shares, which rose 1.5% to 2.0%.

After last Friday’s bounce higher, the S&P 500 closed above its 50-day moving average. It is important for sharp corrections to retake important technical levels quickly. The strength of the recent bounce back rally could be another clue that the June lows will hold. Higher highs and higher lows are what the bulls want to see.

The prevailing sentiment in the market remains negative – with so many market participants remaining bearish, any good news can have an outsized impact. One example is corporate earnings expectations, which have firmed and inflected higher over the past several months.

Recent corporate earnings strength has been led by energy and industrials. Bank earnings have been a bit more challenged, with many banks beginning to add to reserves.

As inflation has risen, value stocks have outperformed growth stocks. This type of price action will not change our focus on holding quality businesses over the long-term – we are not simply “value” or “growth” investors, but support inclusion of both as part of a diversified portfolio.

Fixed Income Takeaways

Last week saw a litany of hawkish comments by Federal Reserve (Fed) governors, in addition to a sharp 75 basis point rate hike by the European Central Bank. Central banks around the world remain focused on controlling inflation, possibly at the expense of global growth.

The Fed will meet next week and is expected to raise the target Fed Funds Rate by another 75 basis points, to 3.25%. After September’s meeting, the pace of rate increases is expected to slow. Market expectations for the terminal Fed Funds rate are 3.75% to 4.25%, with most hikes occurring in 2022.

The US August Consumer Price Index (CPI) report will be released on Tuesday, September 13. Expectations are for a slight month-over-month decline in headline CPI, while the 12-month trailing rate is expected to remain around 8.0%. Regardless of the outcome of this report, the Fed is likely to increase rates by 75 basis points at their meeting next week.

Yields on 10-year Treasury notes have risen since Fed Chairman Powell’s Jackson Hole speech. Historically, 10-year yields are approaching their 40-year downtrend line. If 10-year Treasury yields continue to rise, these higher yields would likely become a headwind to equities (especially longer-duration business models, such as technology companies).

The spread between BB- and BBB-rated corporate bonds has contracted over the past few months, a positive sign for risky assets. In effect, this dynamic is a sign of healthier credit conditions. In total, high-yield bond spreads tightened by 49 basis points last week.

During the summer, liquidity tends to dry up in the high- yield corporate bond market. As market participants have returned to their desks, liquidity has improved. For example, over $50B of new investment-grade corporate bond issuance was priced last week as activity ramped up.

Key Takeaways

  1. Our view that the Federal Reserve (Fed) will not be pivoting to rate cuts soon has proven prescient, so far.

    • Events of the past few weeks have strengthened our belief.
    • In his Jackson Hole speech in late August, Fed Chairman Powell explicitly stated (with respect to controlling inflation), “… we will keep at it until the job is done.”
    • The Fed likely wants to avoid a mistake it made in 1973 when it cut rates prematurely (prior to the peak in inflation) and was forced to reverse policy.

  2. Said another way, the Fed’s job regarding inflation is not done.

    • The Fed seems willing to accept an economic recession over uncontained inflation.
    • For inflation to fall, unemployment usually must rise. Currently, the labor market remains out of balance. Total job openings have remained unusually high, which continues to put upward pressure on wages.
    • Historically, the Fed has never stopped raising rates before the Fed Funds Rate was above the Consumer Price Index (CPI). Currently, the Fed Funds Rate is 2.50%, while the trailing 12-month Headline CPI was 8.50%.

  3. Thankfully, the US economy remains relatively strong, and corporate earnings are holding on.

    • In the US, Purchasing Manager Index (PMI) data indicates that manufacturing is still expanding, albeit at a slower rate than in 2021. Overseas, manufacturing is contracting.
    • However, the outlook for both the economy and corporate earnings is unclear at home (Quantitative Tightening has yet to fully kick in) and is gloomy overseas.

Bottom Line:

  • Assess your exposure to risk: stay (or get to) Neutral equity exposure versus long-term strategic asset allocation targets.
  • Preserve some cash; emphasize quality investments; incorporate “new tools,” such as real assets and alternatives, where appropriate.

Equity Takeaways

After opening slightly higher, stocks dipped lower in early Tuesday trading. The S&P 500 fell about 0.9%, while small caps fell 1.6%. International shares were mixed.

Through the end of August, both the S&P 500 and the investment-grade corporate bond index were down about 16% year-to-date. Stocks and bonds both fell 3-4% in August.

The markets are dealing with continuous cross currents. September tends to be a weak seasonal month in general for stocks (the strongest trading day of the month is usually the first trading day in September). It is unlikely that the market will mount a rally over the next 3-4 weeks.

Two significant intermediate-term to long-term positives exist. It is likely that the stock market has already discounted much of the negative headline news out there.

First, the inflation narrative has started to change. Recent Institute for Supply Management (ISM) data indicates that prices are beginning to fall on a relative basis compared to growth. In addition, copper prices, energy prices and gasoline prices are all significantly lower over the past few months. Headline and core inflation numbers will remain high over the near-intermediate term, but the market is starting to look forward, anticipating slowing inflation as we move through 2023.

Second, the stock market experienced a strong breadth thrust in July through mid-August before pulling back. We are currently in what stock market technicians would describe as a recycling process.

During the breadth thrust, 90% of S&P 500 components moved above their respective 50-day moving averages. During the ensuing quick pullback, fewer than 50% of S&P 500 components remain above their 50-day moving average (counting the first cross over a 6-month lookback period).

This type of pattern has occurred 15 times since 1990; for 13 of those 15 times, forward returns were quite strong.

Bottom line: based on the weight of the evidence, we don’t think the stock market will undercut the lows we saw in June. Think in probabilities and think about what can go right instead of just what can go wrong.

Fixed Income Takeaways

Short-term Treasury yields reached as high as 3.54% last week before moving lower towards the end of the week to close at 3.40%, while 10-year Treasury yields closed the week around 3.20%. The 2-year/10-year Treasury curve was inverted by almost 50 basis points several weeks ago – it is now about 20 basis points inverted after steepening somewhat last week.

Last Friday’s nonfarm payroll report showed a lower- than-expected increase in average hourly earnings, as well as a tick higher in the unemployment rate, which is one reason yields retreated from their highs on Friday.

In early Tuesday trading, yields are higher once again, with 2-year Treasury yields rising 12 basis points to 3.52% (again near last week’s highs), while 10-year yields rose 14 basis points to 3.34%.

Rising Treasury yields weighed on corporate bond spreads last week, which widened as yields rose. Intermediate-term investment-grade corporate bond spreads widened 3-10 basis points on the week.

High-yield bond spreads widened by 41 basis points last week, led by the weakest credits (CCC-rated paper). High-yield bond funds saw significant outflows as investors reduced risk.

Key Takeaways

  1. Federal Reserve (Fed) Chairman Jerome Powell’s comments on Friday at the Jackson Hole Economic Symposium re-affirm the Fed’s commitment to fight inflation with rate increases.

  2. The economy is showing signs of slowing, but also appears strong enough to withstand future rate hikes.

    • The Atlanta Fed GDPNow estimate for third quarter 2022 Real Gross Domestic Product (GDP) growth is +1.6%, which would be an improvement from the first and second quarters, which both saw negative growth.
    • Initial unemployment claims remain at low levels and have yet to inflect higher. The labor market remains strong.
    • On Friday, the Bureau of Economic Analysis report on Personal Income and Outlays showed that Core Personal Consumption Expenditures (PCE) inflation moderated. The PCE Core Price index rose 4.6% year-over-year in July versus expectations of 4.7%, and was lower than the increase of 4.8% last month for June. Headline PCE rose 6.3% year-over-year, versus 6.8% last month.

  3. Given the Fed’s hawkish stance, “good” news for the economy has become “bad” news for the markets.

  4. Markets are likely to remain volatile in the near-term but have tended to rebound before the economy.

    • Markets will typically rebound sharply after the completion of a rate hiking cycle.

  5. Assess your exposure to risk. Stay (or get to) Neutral equity exposure vs. long-term strategic asset allocation targets.

    • Preserve some cash; emphasize quality investments and incorporate “new tools,” such as alternatives and real assets, where appropriate.

International Inflation Update:

  • Global inflation expectations are at a peak (aside from in the United Kingdom). In other words, inflation is expected to drop across the world over the next 12 months in most countries aside from the UK. The UK is likely to face a severe energy crisis this winter and faces a bleak outlook.
  • Recent comments from the European Central Bank (ECB) have mirrored those of the US Federal Reserve. Controlling inflation is the number one goal for the ECB, even at the expense of economic growth.
  • China is in a different spot in the economic cycle compared to the rest of the world. The country is experiencing weakening demand and is embarking on a stimulus program.


Equity Takeaways

Stocks dipped in early Monday trading. The S&P 500 fell about 0.5%, while small caps fell about 0.7%. International shares were mixed.

Last Friday, US stocks sold off 3-4% due to Powell’s continued hawkishness. Clearly, some market participants had been hoping for a more dovish speech.

As noted below, one goal of Powell’s speech seemed to center around dampening expectations for rate cuts in 2023. Since stock prices tend to rally after the end of a rate hiking cycle, Powell’s commentary was seen as negative for the stock market.

Fixed Income Takeaways

After Fed Chairman Powell’s Jackson Hole speech last Friday, market expectations for a 75 basis point rate hike in September increased. Prior to the speech, most market participants had been expecting a 50 basis point hike in September.

In addition, Powell stated that interest rate policy is likely to remain restrictive for some time (implying that rate cuts are unlikely in 2023). Powell did not mention a “soft landing” for the economy in this speech, instead stating that some pain is likely to be felt by households going forward.

Essentially, Powell wanted to ensure that expectations for future rate cuts do not impede the Fed’s main goal of controlling inflation.

Over the next three and a half weeks, prior to the Federal Reserve’s next meeting on September 21, key economic data will be released that may affect Fed policy – the Employment Situation (“the jobs report”) will be released on Friday of this week; the Consumer Price Index (CPI) and Retail Sales will be released in the third week.

Corporate bond spreads widened significantly after this speech, led by the weakest credits. CCC-rated high-yield bonds, which have performed well since June in conjunction with the rally in the stock market, sold off the most.

The 3-month T-bill/10-year Treasury note spread continues to contract. This spread has not inverted yet, but if/when it does, it usually implies economic weakness.

Floating-rate high-yield securities have once again begun to outperform fixed-rate securities, in part because of the sharp Fed Funds rate increases over the past few months. Even though spreads on fixed-rate securities have tightened since June, floating-rate securities still hold value on a relative basis.

Key Takeaways

  1. Markets have rallied on the belief that inflation is slowing while the economy is still growing.

    • Some believe that with inflation slowing, the Federal Reserve (Fed) may pivot away from rate hikes.

  2. Various crosscurrents are a cause for confusion.

    • The housing sector is cracking after several years of red-hot growth, but rental rates are still soaring.
    • Consumer confidence remains low, but consumer spending remains robust.
    • Layoffs and jobless claims are rising, but wage growth remains brisk. The overall level of jobless claims remains very low, however.
    • The European Union (EU) seems destined for a recession. Electricity prices in Germany are up 600% year-over-year, and natural gas prices in Europe are up 500% year-over-year.
    • China is struggling (economically and politically), but the US economy is still growing.

  3. Bottom line: The Federal Reserve (the Fed) may pivot to a pause in their rate hiking cycle; however, a pivot to rate cuts is unlikely.

    • Market expectations are for continued rate hikes in 2022, with a flip to several rate cuts in 2023. If the Fed ultimately does not end up delivering on these expectations, some disappointment may be looming.
    • This coming Friday (8/26), Fed Chairman Jerome Powell will deliver an important speech from Jackson Hole, Wyoming. The message is likely to remain hawkish and focused on controlling inflation.
    • Volatility may rise again as market participants deal with these conflicting messages.

  4. Assess your exposure to risk as part of a continual process.

    • Stay (or get to) a Neutral equity allocation versus long-term strategic asset allocation targets.
    • Continue to preserve some cash while emphasizing quality investments.
    • Incorporate “new tools,” such as alternatives and real assets, where appropriate.

Equity Takeaways

Stocks dropped in early Monday trading. The S&P 500 fell about 1.3%, with small caps falling a similar amount. International shares also fell.

Stock prices often focus on the rate of change rather than absolute levels. The absolute level of inflation remains high, but the growth rate of inflation is slowing. This dynamic has supported stock prices over the past several months.

September tends to be a poor month for the stock market. After a strong rally off the June lows, overall market sentiment has improved from very bearish, to more neutral levels. In other words, negative sentiment is no longer a tailwind. Both factors could lead to a pullback into the 4000-4100 level on the S&P 500 (which closed at 4228 last Friday).

As noted in past comments, we’ve seen very strong stock market momentum signals over the past two to three weeks. After such signals, forward returns on longer-term time horizons are typically strong. Thus, we believe that it is unlikely any near-term pullback will revisit the June lows.

Fixed Income Takeaways

During the upcoming Jackson Hole symposium at the end of this week, the Fed’s message is likely to remain focused on controlling inflation at all costs. Even formerly dovish members of the Committee have recently expressed the view that front-loading rate hikes remains the correct policy.

Expectations for 2-year inflation have dropped significantly in the past several months. In March, this number was about 5% and has dropped to 2.67% recently. The long- term average is 2% (the Fed would like to see this number drop even further).

The real (inflation-adjusted) 2-year/10-year Treasury curve inverted recently. Typically, when this curve inverts, it telegraphs a significant economic slowdown and/or credit spread widening. A similar inversion occurred in 2018 when Fed overtightening led to a sharp stock market sell- off.

The very front end of the municipal bond curve also inverted recently, which is an unusual development. This municipal inversion could also be signaling worries about economic growth.

Key Takeaways

  1. Investors are caught between a tug-of-war: “rates of change” versus “levels.”

  2. Inflation’s rate of change is slowing, but the absolute level remains high.

    • Recently, investors seem to be giving more credence to the slowing rate of change.

  3. Economic growth remains positive but is also slowing – the absolute level of activity remains high.

    • Recently, investors seem to be giving more credence to the level of economic activity and seem less concerned about declining growth rates.

  4. Bottom line: Inflation is gradually slowing, as is the growth rate of the economy. However, the economy is still growing in absolute terms, which is one reason stocks have rallied off the June lows.

    • Wages and employment will remain important indicators. Wages remain firm and jobless claims have remained relatively low. However, the number of total job openings has dropped toward more normal levels, likely indicating that the labor market is beginning to cool.
    • Inflation is still too high and may force the Federal Reserve (Fed) to continue their aggressive policies. For example, despite a recent sharp drop in gasoline prices, food and shelter prices remain stubbornly elevated.

  5. Stocks remain a better bet than bonds for long-term wealth generation, but in the current environment, we remain neutral on equities versus a client’s long-term strategic asset allocation targets.

    • Bonds and stocks continue to move together, which has reduced the diversification benefits of bonds.
    • Stay selective, emphasize quality and incorporate “new tools” for additional diversification where appropriate, such as alternatives and real assets.

Equity Takeaways

After rallying over 3% last week, the S&P 500 dipped about 0.40% in early Monday trading. Small caps fell about 0.75%. International shares also fell.

The tenor of the equity market has been changing since the June lows. Investor sentiment remains poor, indicating that many market participants do not trust the recent rally.

Momentum is key to differentiate between a standard bear market rally and the beginning of a new bull market. Recently, many momentum indicators have begun to confirm a similar message – that the recent stock market rally is broadening and could indicate a sustainable bottom.

The stock market often looks through negative headlines if the forward outlook is improving. It is thus very important to listen to the message of the market.

Fundamentals have also supported the recent rally, as the second quarter 2022 earnings season was not as bad as feared. With about 90% of S&P 500 companies having already reported, 75% of companies reported earnings above expectations. The forward earnings outlook is also holding up better than expected.

As of Friday’s close (8/12/22), the S&P 500 has recovered more than half of the total loss from its 1/4/22 peak.

Since World War II, in the case of nearly all bear markets (defined by a 20%+ peak-to-trough decline), a 50%+ retracement of the initial sell-off has resulted in a new bull market. The lone exception occurred in late 1974, during the global oil embargo.

Fixed Income Takeaways

The 2-year/10-year Treasury curve steepened slightly last week but remains significantly inverted. In early Monday trading, the 2-year note yield was 3.18%, while the 10- year note yield was 2.77%. An inversion of this size is rare, indicating that bond market participants remain worried about future economic growth.

The 3-month/10-year Treasury curve has not yet inverted – the 3-month bill yield was 2.52% in early Monday trading.

The current Fed Funds rate is in the target range of 2.25% to 2.50%. Market participants are pricing a terminal Fed Funds rate of 3.66% in March 2023. About 50 basis points of rate cuts are subsequently priced into the forward outlook between March 2023 and January 2024, implying a Fed Funds rate just above 3.00% at the end of 2023.

In other words, interest rate traders are expecting continued rate increases throughout 2022 but are expecting the Fed to pivot to rate cuts in early-to mid-2023. If market participants turn out to be incorrect about future Fed policy, volatility across asset classes could increase once again.

Credit spreads have tightened significantly over the past few weeks, in conjunction with rising equities. Tightening spreads have also restarted the new issuance market, which showed strong volumes last week.

Key Takeaways

  1. S&P 500: Market is now in the resistance zone. Will it break out?

    • Since leaving June, we are in an upswing. If we get a move above 4150-4200, then that is a breakout that could provide an opportunity for higher highs and lower lows.

    • 200 day moving average is at 4339.

    • This potential breakout zone is definitely something to watch going forward for the rest of the year.

  2. Earnings: Multiples are still moving higher and fueling the rally.

    • In spite of concern for the last earnings calls, they have come in “good enough.”

    • Forward 12-month EPS came in a bit lower than last quarter from peaking ~240 in June to 236.

    • But at the same time, the forward PE ratio is nearly at the same level as last quarter, going up almost 2.5x from the trough in June.

    • The big question: What is the multiple that people are willing to pay for the earnings that they want or expect? It will be a very rate-dependent answer.

  3. Momentum: 20-day highs suggestive of positive 12-month forward returns.

    • Percent of issues trading at a 20-day high has peaked above 53.5% at the end of July. This is a meaningful point as at that point it cuts off all negative returns for the S&P 500 on a 12-month forward basis.

    • Best used in conjunction with other signals but strong on its own.

  4. Momentum: More participants can signal bulls.

    • Percent of issues above the 20-day moving average is close to 92% at 83.7% for S&P 500.

    • Bullish indicator as it bodes well for future returns over a 12-month time horizon as well as a 3- and 6-month time horizon.

  5. Credit: BB-BBB Spread is confirming the recent stock market strength.

    • BB-BBB spread is an indicator of market health as well as credit health.

    • Spread has collapsed by 90 basis points (bps) since June and is within hailing distance to pre-COVID levels.

    • The market looks strong and healthy from a credit perspective.

  6. Buybacks: Volume-weighted average price (VWAP) trend change indicates buyback desk activity which can be considered another bullish tailwind.

    • When the 10-day moving average of the VWAP is above the 50-day moving average, this means that the buyback desks are chasing the market to fill buyback orders that come across their desk. Extra activity from the buyback desks means they are chasing the market.

  7. Employment Situation: July’s Nonfarm Payrolls (NFP)

    • The report showed a very strong headline number, but there are some strange findings when digging into the inputs.

Fixed Income Takeaways

NFP changed the market sentiment and the Federal Reserve (the Fed) has changed its tune that they will be less aggressive. Yields have dropped after the Federal Open Market Committee (FOMC) meeting, with the front end of the curve rising the most. The front end of the curve is controlled by monetary policy. This signals that the Fed is ready to raise rates to control inflation.

Yield curve movements from last week:

  • 1-3-year yield rose 31-37 bps
  • Long-end yields rose 8-20 bps
  • 2-year rose 33 bps last week, closing at 3.23%
  • 5-year rose 27 bps, closing at 2.97%
  • 10-year rose 20 bps, closing at 2.84%
  • 2-year to 10-year curve inverted further last week, to the magnitude of 40 bps
  • 2-year to 10-year curve inverted as well, to the magnitude of 17 bps

The Fed is back in motion and the investors must expect continued outsized rate hikes. The Fed funds future market is anticipating a terminal rate of 3.7% in 1Q23. The next FOMC meeting will have a lot of data to parse through. If the inflation and market data determine that the current course is correct, we could see another 75 bps rate hike.

There are 45 days until the next FOMC meeting: If the Consumer Price Index (CPI) number remains strong from results coming this week, is it possible to have an inter-meeting rate move? Chatter like this happened after the previous FOMC meeting, and it did not come to fruition. It is not the base case scenario, but it could happen. Several Fed board members, historically hawks, are turning to doves.

Credit spreads show market sentiment and they have been very well behaved through this market volatility, most likely because of interest rate movement up across the yield curve.

Investment-grade (IG) spreads were 2 bps tighter last week and IG spreads were 147 bps over Treasuries.

High-yield (HY) spreads were 37 bps tighter last week and HY spreads were 420 bps over Treasuries.

There are good conditions for issuers to come to market. 

Multi-Strategy Takeaways

Active management has made a bit of a comeback story as of last month. The market was tilted to growth and is likely to stay in that space. We did see a slight tilt into value last week, but quality growth has overtaken now. There is usually a different type of style that takes the lead each cycle.

Bottom Line

S&P 500 futures are up about .5% right before the market opened.

Key Takeaways

  1. A tale of two halves?

    • Historically over the past nine decades, the five worst first halves of the year (1932, 1962, 1940, 1970, and 1939) for the S&P 500 performance were declines of between 18% and 45%. In each case, the return for the second half of each year recovered, with gains of between 7% and 53%. For 2022, the first half is down 20% and the second half is up 7% through the end of July.

  2. The US economy is slowing.

    • Second quarter US GDP fell 0.9%, following a 1.6% decline in Q1. The technical debate over a recession is not important. The important point is the economy is slowing down.

    • The US Housing Market is slowing. There is increasing evidence that higher interest rates and hesitant buyers (due to elevated home prices) are leading the US housing sector towards a slowdown. Redfin recently reported that the four-week rolling average of homes for sale, which included a price drop, rose to more than 7% – double the typical rate from previous years and a record since their survey began in 2015.

  3. Sentiment is so bad, it is good.

    • Consumers are still net bearish on stocks. Bearish sentiment has been one of the most persistent reasons to be bullish over the last several months.

    • For the rally to continue, however, there needs to be some “hard data” to support falling inflation AND stabilizing growth.

  4. The Federal Reserve (Fed) continues to tighten monetary policy.

    • At its Federal Open Market Committee (FOMC) meeting on July 27, the Fed raised the Fed Funds rate by 0.75% (75 basis points) for the second consecutive month. In less than five months, the Fed has quickly raised interest rates 225 basis points, returning to the peak of the last interest rate cycle.

    • Was that another Powell pivot? No, but perhaps a pirouette. Chair Powell said Wednesday it was too soon to say whether the Fed would dial down the size of its rate increases to a half-percentage point or a quarter-percentage point at its next meeting in September. But he said that at some stage, it would be appropriate to slow the pace of rate increases to assess their cumulative impact on the economy.

    • Indeed, Powell seemed to suggest the economy may already be downshifting, although he firmly dismissed the argument that a recession has already begun: “Are we seeing the slowdown in economic activity that we think we need?” Mr. Powell said. “There is some evidence we are, at this time. That said, with 2.7 million people hired in the first half of the year, it doesn’t make sense that the economy would be in recession,” he added.

  5. The timing of a recession can often be unclear.

    • Recessions are declared well after they begin. In fact, sometimes they end before they officially start. The National Bureau of Economic Research (NBER) is the official entity that defines a recession and the beginning and ending dates, respectively. Since the 1980s, the past six recessions have been declared by the NBER approximately 6 to 9 months after they began.

    • Coming out of a recession, the stock market tends to recover before the economy.

Bottom Line:

  • Risk assets have rallied hard on the back of bearish sentiment and hope that inflation will cool, which will cool the Fed.

  • Economic growth declined for the second consecutive quarter; and while the debate over already being in a recession has intensified, the bigger point is that the economy is slowing

  • Although the economy is slowing, wage inflation is still rising – which will keep the Fed on the offensive, although the next FOMC meeting is seven long weeks away.

  • We continue to believe Equities are best for longterm wealth generation; but investors should stay neutral versus their strategic asset allocation targets for now and invest capital judiciously, stay selective, and emphasize quality.

  • We also believe investors should maintain a slight over-weight position to cash (dry powder), along with Alternative Strategies and Real Assets for diversification purposes, where appropriate.

Equity Takeaways

Stocks opened slightly lower in early Monday trading. The S&P 500 fell about 0.2%, with small caps declining about 0.5%. International shares also fell slightly.

Second quarter earnings have been better than expected. Thus far, 56% of the companies in the S&P 500 have reported earnings to date for the second quarter. Of these companies, 73% have reported EPS above analysts’ estimates. The percentage of companies reporting EPS above the mean EPS estimate is below the 1-year average (81%) and below the 5-year average (77%), but above the 10-year average (72%).

At the same time, earnings estimates are coming down while stocks are moving up. Confused? That’s understandable. Even though earnings estimates are coming down (something we’ve been telegraphing for months now), stocks have scaled the wall of worry.

While some earnings reports may have been worse than expected, perhaps they were better than feared. Falling bond yields and ebbing inflationary pressures have also boosted stocks, especially those that came under the most pressure earlier this year when interest rates were moving up (high growth).

Roughly 150 companies in the S&P 500 are yet to announce second quarter earnings this week. Will this trend continue? Time will tell, but we think volatility will inevitably return.

Fixed Income Takeaways

As mentioned above, the Fed raised interest rates by 0.75% last week. The Fed’s official statement was hawkish, but the press conference was dovish, as indicated by the stock market rally. Market participants seem to be anticipating that the Fed will slow down interest rate hikes for the remainder of the year.

Looking ahead, the Fed stated it will be “data dependent” and eliminate forward guidance to preserve credibility. New information will be considered at each meeting. This was interpreted by market participants as leading to the notion that the Fed is slowing down.

Yields declined last week due to mixed economic data: 2-year notes fell 9 basis points (bps) to a yield of 2.90%, 5-year notes fell 18 bps to a 2.70%, and 10-year notes fell 14 bps to a 2.64%. The yield on the 10-year note fell to its lowest level since April of this year.

The 2-year/10-year Treasury curve remains inverted to the order of -26 bps. The rally in Treasuries is likely due to a flight to safety in light of a future economic downturn.

Investment-grade (IG) spreads were tighter by 3 bps for the week; the 3% month-to-date (MTD) return for July 2022 was the best since July 2020. High-yield (HY) spreads were tighter by 17 bps for the week; the 5% MTD return for July 2022 was the best since October 2011. The market is “risk-on” for credit right now. More issuers are coming to market again; IG issuance is estimated at $30 billion for this week and $90 billion for the total month of July.

Key Takeaways

  1. Housing data showed signs of slowing activity last week.

    • Building permits, housing starts, and housing completions all dropped month-over-month in June.

  2. Leading economic indicators also showed signs of a slowing economy.

    • The Conference Board’s composite index of leading indicators declined for the third month in a row.

  3. Initial unemployment claims continued to rise.

    • For the week ending 7/16/22, initial claims were 251,000, the highest level in eight months.
    • Initial claims are a leading indicator of the economy, while the actual unemployment rate is a lagging indicator.

  4. Earnings season is off to a rocky start.

    • Forward estimates have already dropped slightly, and to this point, second quarter 2022 forward guidance has been disappointing.

  5. The European Central Bank (ECB) raised rates by 50 basis points (bps) to combat inflation.

    • This action by the ECB was the first rate hike in 11 years.
    • Prior to this hike, the ECB’s benchmark rate was negative, at -0.50%. The recent policy action brought interest rates to 0.0%.
    • As part of this policy action, the ECB created the Transmission Protection Instrument (TPI) protocol, which will allow the ECB to buy bonds from various European countries to manage overall borrowing costs.

  6. The Federal Reserve (Fed) will meet this week (July 26-27)

    • Expectations are for a 75 bps rate hike, which would bring the Fed Funds Rate to a range of 2.25% to 2.50%.
    • This coming Friday (just after the Fed meeting), updated data on consumer spending and Personal Consumption Expenditures (PCE) inflation will be released. PCE inflation data is the Fed’s preferred inflation metric.

  7. The US Dollar has been extremely strong this year versus other currencies due to the Fed’s aggressive interest rate increases.

    • A rising dollar subtracted 3.2% from first quarter 2022 US Gross Domestic Product (GDP), as US exports fell significantly due to the rising dollar.
    • A rising dollar also puts severe pressure on emerging market countries, as most commodities are priced in US dollars.

Bottom Line:

Even though many forward-looking measures of inflation have declined significantly over the past few months, the Fed continues to stress the importance of controlling inflation and seems likely to continue its aggressive rate hiking policy in the coming months.

Leading economic indicators are also showing signs of a slowing economy, yet recession indicators remain mixed. Quarter two GDP data will be released this Thursday.

Equities are compelling for long-term investors, but near-term volatility will likely persist. Capital should be put to work judiciously on pullbacks. Recall that markets tend to rebound before the economy comes out of a recession (when we get there).

Bonds have become more attractive, and we will continue to evaluate our current “underweight” position.

Equity Takeaways

Stocks opened slightly higher in early Monday trading. The S&P 500 rose about 0.2%, with small caps rising about 0.4%. International shares also rose slightly.

The US stock market is at a moment of truth. This upcoming week will be a very busy one in terms of earnings reports, with almost 50% of S&P 500 market capitalization reporting this week.

Market participants remain focused on the macroeconomic picture. Even companies that have beaten on both revenue and earnings have not been rewarded greatly during the past few weeks.

The recent stock market rally feels like a bear market rally. For us to get more aggressive, we’d like to see more participation from cyclical sectors vs. defensives, as well as stronger measures of overall breadth.

Fixed Income Takeaways

The 2-year/10-year Treasury curve remains inverted, however, the 3-month/10-year curve remains positively sloped. Early on Monday, 3-month bills yielded 2.48%, 2year notes yielded 3.02%, and 10-year notes yielded 2.83%.

On Wednesday, the Fed will release its decision on interest rates. A 75 bps hike is well anticipated by market participants. Any deviation would be considered a large surprise.

Over 60 central banks have raised interest rates by at least 50 bps this year. Inflation is a global phenomenon.

Interestingly, even though market participants expect the Fed to aggressively hike rates over the next few months, expectations for the terminal rate have declined over the past several weeks. The market now anticipates a terminal Fed Funds rate of about 3.40%, down 10 bps in the last week.

High-yield bond spreads tightened 25 bps last week and have shown strength over the past few weeks. Improving credit conditions are generally a positive tailwind for equities as well.

Key Takeaways

  1. Inflation is still accelerating, although everyone is asking: “Is inflation peaking?”
    • Several forward-looking inflationary signals are cooling, which will inevitably allow the Federal Reserve (Fed) to eventually become less aggressive with policy tightening.
    • Many types of commodities – including gasoline, wheat, and copper – have fallen significantly in price over the past several months.
    • Other market-based measures of inflation, such as 5-year breakevens, are also showing declining expectations for future inflation.
  2. Even if inflation peaks soon, it will likely remain too hot for the Fed’s liking.
    • The Fed has recently stated that they would prefer a recession as opposed to runaway inflation.
    • Expect the Fed Funds Rate to continue to rise. The current Fed Funds target rate is 1.75% and is expected to rise above 3.50% in the coming months before peaking in early 2023.
    • After the release of the June Consumer Price Index (CPI) data on July 13, which showed continued high inflation, market participants now expect the Fed to increase interest rates by another 75 basis points (bps) in their late July meeting. Details are included below.
  3. Second quarter 2022 earnings season is off to a rocky start.
    • Earnings estimates for the second half of 2022 and full-year 2023 still seem too high.
    • Growth will likely be a primary concern later this year, as opposed to inflation.


Portfolio Recommendations:

Equities remain the best asset class for long-term wealth generation. Due to ongoing uncertainty about the forward outlook, KeyBank Investment Center continues to recommend a “Neutral” allocation to equities relative to a client’s long-term strategic asset allocation target. Invest capital judiciously, stay selective, and emphasize quality. Maintain slight overweight to cash (dry powder). Continue to utilize Alternatives and Real Assets for additional diversification where appropriate.

Equity Takeaways:

Stocks rose in early Monday trading. The S&P 500 rose about 0.8%, while small caps rose 1.2%. International shares also rose.

Late last week, Fed Governor Christopher Waller commented that a 100 bps rate hike was not likely at the upcoming July meeting, and he also walked back expectations for September from a 75 bps hike to a 50 bps hike.

This slightly less hawkish tone from a prominent Federal Reserve official has bolstered sentiment over the past few days. US stocks rose almost 2% on Friday and continued higher early on Monday.

Second quarter 2022 earnings will be less important than forward guidance. In other words, even if companies exceed second quarter expectations, commentary on the forward outlook will be more important. The macroeconomic outlook is driving stock prices more than individual company earnings at this point.

The Private Equity and Venture Capital markets have not been immune to the recent volatility – during the second quarter, total transaction value slipped to $221 billion, down 29.4% from the same quarter last year.

Fixed Income Takeaways:

Last week, the 2-year / 10-year Treasury curve inverted by as many as 20 basis points, the largest said inversion since the year 2000. The inversion was caused by the hot CPI data released last Wednesday.

Short-term Treasuries are more sensitive to Federal Reserve policy, while long-term Treasuries are more sensitive to long-term growth expectations. After last Wednesday’s CPI data, short-term Treasury yields rose more than long-term yields, inverting the curve. Immediately after last Wednesday’s CPI data, expectations were that the Fed would hike rates by 100 basis points in July and another 75 basis points in September. As noted above, subsequent commentary from Fed Governor Waller walked back those expectations. Consensus is now that the Fed will hike rates 75 basis points in July and another 50 basis points in September.

3-month Treasury Bill yields jumped by 38 basis points last week, a significant move which has flattened the 3- month / 10-year Treasury curve. 3-month bills were yielding 2.37% early on Monday, while 10-year notes yielded 2.99%.

Corporate credit spreads tightened Friday, in both highyield and investment-grade (IG) bonds, to close flat to slightly tighter on the week. New issuance remains muted, which has provided technical support for spreads due to relative lack of supply.

As the Treasury curve inverts, the Municipal bond curve typically does not invert. As a result, short-duration Municipals have once again become very expensive relative to Treasuries. Investors should favor Treasuries versus Municipals inside 1-year maturities where possible.

Key Takeaways:

  1. Are we in a recession?

    • Not yet, but the economy is slowing, and risks are rising. This week’s Retail Sales report will be important to watch, as last month’s report showed some weakness in real consumer spending.
    • Last Friday’s nonfarm payroll report showed continued strength in wages. Average hourly earnings advanced 6.35% year-over-year, a slight decline from the previous month. The Federal Reserve (Fed) will likely remain aggressive while wages are rising above 6% year-over-year.
    • The Sahm Rule Recession Indicator is not a forecasting tool, but historically it has been accurate at marking the beginning of recessions. The indicator is triggered when the three-month moving average of the U3 national unemployment rate rises by 0.50% or more relative to its previous 12-month low. Currently, unemployment remains near 12month lows, so the Sahm Rule is not indicating recession.

  2. Has the Fed disavowed the term “transitory” just as inflation may prove “transitory?”

    • The week’s Consumer Price Index (CPI) report, and the market’s reaction, will be very important. The Fed, in recent communications, has stated that their main goal in the current environment is to control inflation.
    • Several forward-looking market measures of inflation have declined recently. Examples are 5-year/5-year forward inflation expectations, as well as commodity prices.
    • Increasing fears of recession have put a damper on near-term commodity prices. That said, on a longterm horizon, many commodities are facing supply shortages. Structural issues plaguing energy markets have not been resolved.

  3. Will Second Quarter 2022 earnings disappoint?

    • Perhaps, but the forward earnings outlook will matter even more for equity markets and 2H:2022/FY:2023 guidance looms large.

Our Outlook.

  • The next six months or so could continue to be rocky – a lot needs to go right.
  • Looking out approximately 12 months, the economic narrative may be completely different. Inflation may have crested, and the Fed may have paused rate increases (or already be easing policy).


Equity Takeaways:

Stocks fell in early Monday trading. The S&P 500 dropped about 1.1%, while small caps fell 0.8%. The tech-heavy Nasdaq fell about 2%. International shares also fell.

Last Friday was the slowest trading of the year – the summer doldrums are here. Volume and liquidity will likely dry up until Labor Day.

The 2Q:2022 earnings season will kick off in earnest this Thursday-Friday. Market participants continue to grapple with a slowing economy: are we heading into a recession, or just a growth scare?

Our base case continues to be that earnings-per-share growth will slow, but that economic momentum may allow the US economy to avoid a full recession.

In prior recessions, corporate earnings contracted by about 15% on average. The market Price/Earnings multiple will typically contract to about 13x during a recession, versus the long-term average of 17x.

For context, the street estimate for FY 2023 S&P 500 earnings per share is about $250 (forward earnings estimate beginning in 1Q 2023). As of the time of this writing, the S&P 500 was trading around 3850, which equates to a 15.4x forward multiple for FY 2023. 

Fixed Income Takeaways:

Last week’s June nonfarm payrolls report was stronger than expected, reinforcing market expectations that the Federal Reserve will raise rates by another 75 basis points (bps) later this month. The current Fed Funds range target is 1.50% to 1.75%.

Due to last week’s strong employment report, Treasury rates rose across the curve. Short-term rates rose faster than long-term rates, resulting in a small 2-year /10-year curve inversion. Early on Monday, the 2-year Treasury yielded 3.06%, while the 10-year Treasury yielded 3.01%.

High-yield bond spreads tightened by 56 bps last week, led by BB-rated bonds, which tightened 61 bps. Overall high-yield spreads are still about 200 bps wider year-todate but remain below the peak levels reached in 2015/2018. Spreads are still well below recessionary levels.

The lowest-quality bonds (CCC-rated) have fared the worst during the recent market weakness. Overall cumulative amounts of distressed debt have increased slightly, but also remain well below recessionary levels.

On a fundamental basis, corporate leverage ratios, interest coverage and cash on balance sheet all look healthy. The high-yield marketplace will not face a significant number of maturities until 2025.

Key Takeaways:

  1. Some inflation risks are trending lower.

    • Headline inflation numbers, which include food and energy prices, generally continued to trend higher in May. Conversely, core inflation numbers, which strip out food and energy, decelerated slightly in May.
    • Various commodity prices, such as copper, aluminum, and wheat, have dipped sharply in the past several months. Gasoline futures (which tend to be less volatile than spot gasoline prices) have also declined in the past several months.
    • The Biden administration seems poised to reduce tariffs on Chinese goods – this move could also help lower inflation.

  2. Recession risks are trending higher.

    • The Federal Reserve (Fed) seems willing to let a recession happen to quell inflation.
    • The 2-year/10-year Treasury curve has flattened significantly again, which tends to indicate worries about future economic growth.
    • Weekly initial jobless claims were as low as 170,000 in April 2022. The most recent weekly jobless claims number (for the week ending June 25) was 232,000 – indicating that claims have clearly inflected higher. The overall unemployment rate for May was 3.6%; however, it is a lagging indicator. The unemployment rate for June will be released on Friday of this week.

  3. Investors’ willingness to embrace risk may be timeperiod dependent.

    a. The next six months or so could continue to be rocky.

    • For risky assets to find their footing, inflation needs to cool, while the Fed needs to slow down their pace of monetary tightening.
    • Corporate earnings also need to remain strong, although it is very likely that we will see a slowdown in the coming months. In a typical recession, earnings fall about 15%.
    • A workable peace between Ukraine and Russia would obviously be a very positive development.

    b. Twelve months or so from now, the economic narrative may be entirely different.

    • Inflation may have crested by this point, and the Fed may have paused their rate hiking cycle (or may already be easing rates).
    • Markets tend to anticipate changes in the economic landscape (both positive and negative).

Equity Takeaways:

After rising about 1% last Friday, stocks fell sharply in early Monday trading. The S&P 500 fell about 1.6%, while small caps dropped over 2%. International shares generally fell 2-3%, led by weakness in the Eurozone.

June equity returns were very poor. US stock markets dropped about 8%, developed international markets dropped about 9%, and emerging markets dropped over 5%. In the second quarter, US large cap equities dropped about 16%.

The S&P 500 dropped about 20% in the first half of 2022, one of the worst ever starts to a calendar year. The previous five worst first halves occurred in 1932, 1939, 1940, 1962, and 1970. In each of those years, the second half calendar year return was positive.

The current bear market is 6 months old (cycle peak was 1/3/22). The average bear market, going back to 1929, lasts 11 months. The median bear market lasts 8 months. The speed of the monthly decline during this year’s decline has been below average – a “run of the mill bear.” Volatility has remained muted during the downturn (trading has generally been orderly).

To get a capitulatory low, volatility would likely need to increase significantly to signal a full washout. Implied volatility (VIX) was 29.5 in early Monday trading – capitulation usually sees significantly higher readings on the VIX (36+).

S&P 500 earnings estimates have begun to inflect lower. Analysts are typically slow to revise estimates. Most of this year’s decline can be attributed to Price/Earnings multiple compression, as earnings have held up well to this point.

Fixed Income Takeaways:

In the last three weeks, 10-year Treasury yields have dropped about 60 basis points, to their Monday morning level of 2.81%. The 2-year Treasury yield was 2.80% in early Monday trading (the yield curve is very flat, reflecting> increased concerns about future economic growth).

High-quality core bonds dropped 4.7% in the second quarter and have declined over 10% year-to-date.

Credit spreads widened significantly over the past month, with high-yield bonds dropping 6.7% in June. Both corporate and municipal bond issuance has remained muted due to the market volatility.

Mutual fund flows remain a headwind to both the corporate and municipal bond markets. Investors continue to pull funds from almost all types of fixed income.

Key Takeaways:

  1. Investors seem certain that the forward outlook is bleak.

    • Does anyone NOT think a recession is coming? Even the Chairman of the US Federal Reserve (Fed), Jerome Powell, recently said it will be “challenging” to return to 2-percent inflation with a strong labor market.
    • If everyone “knows” a recession is coming, would it still be considered a surprise when that recession materializes?

  2. That said, it’s not a time for complacency either.

    • Central Banks around the world are still tightening policy. Recent comments from Fed Chairman Powell have primarily focused on controlling inflation, and at the same time, economic growth is slowing.
    • Higher prices may be weighing on commodity demand (many prices have recently retreated from recent highs), but the inflation rate will need to decline for stocks to fully recover.

  3. Some think we’re already in a recession (we disagree).

    • A recession is defined by the National Bureau of Economic Research (NBER) as “a significant decline in economic activity that is spread across the economy and lasts more than a few months.”
    • Three criteria are used to determine whether the economy is in a recession: depth, diffusion and duration across a wide cross-section of economic activity.
    • The economic outlook is certainly weakening, but it’s also important to remember that the economy entered 2022 with strong momentum.
    • Markets typically move faster than economies (and economists). In the last six recessions, stocks had already moved materially higher by the time a recession was officially declared.

  4. Above all, resilient portfolios are needed.

    • As noted in more detail below, the stock market is currently discounting a large amount of negativity, yet corporate earnings have held up well to this point.
    • KeyBank Investment Center continues to recommend that investors remain focused on their long-term financial plan. After the sharp declines of this year, adding additional cash to the markets in stages is likely a winning long-term strategy.
    • Resilient portfolios should also include additional diversification in the form of real assets and alternative investments where appropriate.

Equity Takeaways:

Stocks were mixed in early trading on Monday. The S&P 500 fell about 0.3%, while small caps rose slightly. International shares were also mixed. Trading this week is likely to be quiet going into the July Fourth holiday weekend.

Approximately a week ago, we saw signs of capitulation in the cryptocurrency markets, which may have helped support a rally in other risky assets last week (such as equities). Indeed, the S&P 500 bounced over 6% last week.

2Q:2022 earnings season will begin in two weeks. Market participants are expecting companies to underperform current analyst estimates (investor sentiment is very negative). Stock prices are already discounting a weakening earnings picture – 2Q:2022 would need to come in materially weaker than expected to force another leg lower in the market.

Conversely, because of the current negativity pervasive in the marketplace, stocks could be set up for a short-term rally towards 4000-4100 for the S&P 500 (from the current level of about 3900).

The typical mid-term election-year pattern usually results in choppy summer trading, followed by a bottoming process in autumn (usually coinciding with the November elections). While it is very difficult to predict short-term market movements, historical seasonal patterns will begin to turn positive in late 2022. Thus, averaging into the market on weakness as we move through 2022 likely makes good long-term sense.

Implied volatility (VIX) remains relatively low despite the weakness in equities over the past months. At its current level of 28.5, the VIX remains well below the panicky levels we saw earlier in 2022.

Fixed Income Takeaways:

KeyBank Investment Center participated in a fixed income conference last week. Most conference participants thought that the Federal Reserve would need to remain aggressive on inflation at the expense of economic growth.

Conference participants also worried that the European Central Bank (ECB) is farther behind the curve on inflation than the US Federal Reserve, and would thus be forced to raise rates even more aggressively than the Fed.

Despite a rally in long-term Treasury prices last week, 3-month and 6-month Treasury bills continued to move higher in yield, flattening the overall yield curve. 6-month Treasury bills were yielding 2.44% in early Monday trading, while 10-year notes yielded 3.17%.

On a long-term basis, investment-grade (IG) credit spreads are not at alarming levels. Even if spreads were to drift a bit wider throughout the year, overall spreads are not at levels that would indicate a crisis.

There has been much attention paid to CDX spreads, which are a measure of the cost to protect corporate credit against default risk. Many fixed income market participants believe that CDX spreads are not a great leading indicator for cash bonds, given that CDX is more thinly traded (less liquid).

General Takeaways:

  1. Last week, the bear market turned even grizzlier.

    • This year’s sell-off in equities widened as the Federal Reserve (Fed) and other central banks around the world grew increasingly hawkish.

    • Last Wednesday, the Fed raised rates 75 basis points (bps), after noting that a 75 bps hike was not under consideration just a month ago.

  2. Central banks, starting with the US Fed, are now determined to fight inflation and appear willing to take the economy into a recession.

    • The Fed does not believe that a recession is inevitable, but inflation is clearly their #1 focus.

    • The Fed is likely to raise rates an additional 50-75 bps in July. Other central banks around the world are also embarking on tightening programs after years of very low rates. China is the exception – Chinese officials are holding off on rate increases for now.

    • The Fed expects that the Fed Funds rate will peak in 2023, before declining in 2024.

  3. Recent data points indicate that the economy is cooling.

    • Corporate earnings estimates are likely still too high, as Wall Street analysts are typically late to revise estimates lower.

    • Much of the Fed’s work (damage/financial tightening) has likely already been done.

    • Metrics that the Fed is likely watching include wage growth, job openings, consumer sentiment, existing and new home sales, etc.

  4. Not all bear markets are alike.

    • Last week, the decline from the 1/3/22 peak in the S&P 500 eclipsed 20%, placing us in bear market territory.

    • KeyBank Investment Center views the current situation as a cyclical bear market within an ongoing expansion, as opposed to a long-term structural or secular bear market.

    • Cyclical bear markets tend to resolve more quickly, with shallower peak-to-trough drawdowns, than structural bear markets.

  5. Resilient portfolios are needed – in this type of environment, diversification is paramount.

    • Alternatives, including private strategies and hedge funds, have held up much better than traditional stocks and bonds this year.

    • Where appropriate, we continue to recommend that clients consider adding alternative strategies to portfolios (including real assets).

Equity Takeaways:

Stocks rose in early Tuesday trading. The S&P 500 rose 2%, while small caps rose 0.75%. International shares also rose.

The S&P 500 has dropped over 10% in the past two weeks. The Consumer Price Index (CPI) report on June 10 exacerbated fears of persistent inflation. As noted above, Fed officials have become increasingly hawkish on inflation in recent weeks, which has weighed on markets across the globe.

The typical bear market takes about 289 days to move from peak-to-trough, however, durations can vary wildly. As noted above, KeyBank Investment Center believes that the current drawdown is likely a cyclical bear market related to a slowing economy, not the start of a new long-term structural bear market.

Equity Price/Earnings (P/E) ratios have contracted significantly during the recent sell-off. For example, the S&P 600 SmallCap Forward P/E ratio has declined to 10.8, which is approaching levels last seen in the 2008-09 and 2020 market drawdowns.

Fixed Income Takeaways:

US Treasury yields have risen sharply in recent weeks in conjunction with increasingly aggressive Fed policy. 10- year Treasuries yielded 3.30% early on Tuesday, up from 2.85% at the end of May. 2-year Treasuries yielded 3.23% in early Tuesday trading, up from 2.55% at the end of May.

Up until a few days before last Wednesday’s Federal Reserve meeting, Chairman Powell seemed to be against a 75 bps rate hike. A key quote from Powell at last week’s meeting: he “doesn’t expect moves of this size to be common.”

Powell did note that a 50-75 bps hike is likely at the July meeting as well. After these moves, the Fed’s forward guidance has been called into question. Aggressive rate hikes are likely at the next several meetings. The pace of hikes is expected to slow later in the year.

The Fed’s updated Summary of Economic Projections does not call for a recession over the next few years; however, it does call for an increase in the unemployment rate. Powell would not use the term “soft landing” at his press conference last week.

Even municipal bonds were swept up in last week’s market sell-off. Last Monday, municipal bond yields rose 25 bps in a single day, and over 35 bps on the week. It was the worst week for municipal bond prices since April 2020.

Fund flows continue to weigh on municipal bonds. Over $70B has flowed out of municipal bonds year-to-date (YTD). After looking cheap earlier this year, with treasury yields also having risen, municipals are back to fair value or slightly expensive vs. treasuries.

General Takeaways:

  1. Inflation is too hot.

    • Eventually, inflation will moderate, but the Federal Reserve (Fed) may have to induce a recession to squelch it.
    • Last week’s Consumer Price Index (CPI) report showed that inflation has not yet peaked. The largest contributor was gasoline prices, but food and shelter prices also continued to rise sharply.
    • The Fed is still likely to raise interest rates by 50 basis points (bps) during their meeting later this week, although some forecasters are now predicting a 75 bps increase during at least one of their upcoming meetings.

  2. Four things to watch when gauging recession risks.

    • Indicators like the Sahm Rule, which captures a reversal in the unemployment rate of at least 50 bps, are very good at identifying recessions once they’ve occurred, but are not good at predicting them. Currently, it is not sensing a recession as the employment backdrop is still quite healthy.
    • Treasury yield curves continue to send mixed signals (see fixed income section for details).
    • Credit spreads have widened, but the move has been orderly for the most part. That said, over the past several days, trading in the credit markets has become increasingly volatile.
    • The price of oil remains a major headwind to the economy. History suggests that when the price of oil spikes above 100% year/year, a recession may be lurking.

  3. Near-term risks are skewed to the downside.

    • Economists will be closely watching consumer spending. The US consumer is a bigger contributor to World GDP than Japan, Germany, the UK and Italy’s economies combined.
    • Investors should watch for negative earnings revisions – Wall Street analysts are generally slow to move their numbers lower.

  4. More resilient portfolios are needed.

    • KeyBank Investment Center continues to recommend additional diversification in the form of real assets and alternative investments (where appropriate). Active managers may also be able to add value in the current environment.
    • Holding a bit of extra cash also makes sense due to the recent volatility.
    • The economy and the stock market move at different speeds. Inflection points/reversals in the stock market can come without warning and are generally positively skewed.
    • Many times, the stock market will begin to anticipate an economic recovery before the data itself begins to improve. In other words, stocks lead the economy.


Equity Takeaways:

After a sharp fall last Friday, stocks continued to lower in early Monday trading. The S&P 500 fell 2.5%, while small caps fell over 3%. International stocks also fell. The proximate cause of last week’s sell-off was Friday’s CPI report, which showed higher-than-expected inflation.

Since 2009, credit spreads have been a good leading indicator for stocks. High-yield bond spreads are gapping out again Monday morning. Disorderly trading in high- yield bonds generally spills over to stocks.

After a stock market drawdown of 20%, stock market returns are generally positive looking out on longer timeframes. That said, in the recent past, the Fed has stepped in to support the stock market during downturns, a dynamic that does not exist in the current environment. In other words, the Fed does not currently have the market’s back.

This morning, the S&P 500 is breaking through the recent interim lows in the low 3800s. 3600 on the S&P 500 is the next obvious level of technical support

Fixed Income Takeaways:

US Treasury yields gapped higher last Friday, with the 2- year Treasury yield increasing 25 bps, the largest one-day move higher in yields since 2009. In total, 2-year yields rose 36 bps last week.

The longer end of the Treasury curve also rose sharply last week (although not as much as 2-year yields). In early Monday trading, yields were rising again – the 2-year yield was 3.22%, while 10-year Treasuries yielded 3.28%.

The US Treasury yield curve is showing conflicting economic signals. The 3-month / 10-year spread is still solidly positive; however, the 2-year / 10-year spread is close to inverting once again. Recall that an inverted yield curve implies that market participants are concerned about slowing economic growth.

Traders are now pricing in 50 bps rate hikes over the next three Fed meetings (June, July and September). For the July meeting, market participants are assigning a 55% chance to an even larger, 75 bps rate hike.

Investment-grade (IG) spreads moved 4 bps wider on Friday and 6 bps wider on the week. High-yield spreads moved 10 bps wider on Friday and 32 bps wider on the week.

CDX spreads (a measure of the cost to insure against corporate default) also moved sharply wider last week and are moving wider again Monday morning. High-yield CDX spreads are at their widest level since 2018.

The reduction of the Fed’s balance sheet, also known as Quantitative Tightening (QT), began recently. This dynamic is akin to an additional 25 bps rate hike. The Fed is not actively selling bonds, it is simply letting existing holdings roll off.

General Takeaways:

  1. Good News: inflation may be coming down (at the “Core”) – excluding food and energy.

    • According to the Federal Reserve Bank of Cleveland, the Core Consumer Price Index (CPI) is expected to fall from 6.1% in April, to 5.9% in May and 5.5% in June.
    • Both total employment and the labor force participation rate have recovered significantly and are now near pre-pandemic levels. As workers continue to return to the labor force, upward pressure on wages may abate.
    • The Biden administration is considering the reduction of certain Chinese tariffs to counteract inflation. Combined with a possible re-opening of the Chinese economy, the supply situation out of China may improve in the coming months.
    • In the United States, a recession in 2022 still seems unlikely. If the price of gasoline does not stabilize, the likelihood of a recession will grow in 2023.
    • Europe’s economy, in aggregate, is holding up better than feared several months ago, too.

  2. Bad News: company earnings estimates are also coming down.

    • Overall, earnings have held up reasonably well given all the macro challenges we have faced, but forward estimates are beginning to flatten out.
    • If inflation has indeed peaked, market participants may become more focused on long-term earnings potential/growth.

  3. Big News: we may be witnessing the end of a two- decades-long regime.

    • For the past 20 years (2000-2020), inflation was low. Stock prices and bond prices were inversely correlated during this time. As stock prices fell, bond prices generally rose – thus, bonds were a good hedge for stocks.
    • In the prior 40 years (1960s-2000), inflation was elevated and volatile. During these times, stock and bond prices were positively correlated, tending to move in the same direction.
    • If inflation has once again risen to a secularly high level, the diversification benefit from holding bonds may be reduced.
    • For these reasons, KeyBank Investment Center continues to recommend additional diversification in the form of real assets and alternative investments where appropriate.

Equity Takeaways:

Stocks rose in early trading on Monday. The S&P 500 rose about 1.5%, while small caps rose 0.7%. International shares also rose.

The 12-Month Forward Price/Earnings (P/E) multiple of the S&P 500 has fallen recently to about 17.5x. The multiple has contracted for many reasons, including rapidly rising interest rates and flattening earnings estimates.

The current P/E level of about 17.5x is close to the long- term average for the S&P 500. Technology stocks, even after a steep recent pullback, are still relatively expensive, trading about 18% above their long-term average P/E. Energy stocks, even after a significant recent rally, are still trading 32% below their 10-year average P/E multiple.

In recent years (1998, 2011, 2015, 2018), “growth scares” with no ensuing recession have seen average drawdowns in the S&P 500 of about 18%.

The recent cycle peak occurred on 1/3/22, and the year- to-date maximum drawdown occurred on 5/19/22, with the market closing down 18.7% from the peak.

Fixed Income Takeaways:

US Treasury yields drifted higher last week and continued that trend in early Monday trading, with the 10-year note yielding 2.99%, 5 basis points (bps) higher on the day and about 25 bps higher in the past week.

Early on Monday, the 2-year note was trading at 2.70%, 2 bps higher on the day and about 20 bps higher in the past week.

The Federal Reserve does not want to cause a recession. Even if we avoid a recession and obtain a “softish” landing, the macroeconomic environment will likely feel like a recession at times.

General Takeaways:

  1. Are we out of the woods after last week’s strong rally? Probably not.

    • Inflation, as measured in a variety of manners, appears to have peaked. However, the absolute level of inflation remains high and is likely to remain elevated throughout the year.
    • Likely to further compound inflationary pressures, the European Union committed to a partial ban on Russian crude oil this past weekend.

  2. Will we see an epic equity market decline on the order of 40-50%? Probably not.

    • Corporate margins hold the key and to this point have held up well.
    • The economy is undergoing a complicated shift. Purchases of goods are leveling off, while service activity continues to increase. For instance, surveys of trucking activity remain strong but appear to have peaked, while airline survey activity continues to increase and recently surpassed pre-pandemic levels.

  3. Are we heading towards a recession?

    • A recession in the US seems unlikely in 2022. Yield curves, such as the 10-year Treasury rate minus the Fed Funds rate, are flattening, but are not yet at recessionary levels. If the US experiences a recession, it will likely occur in 2023 or 2024.

  4. What could go wrong from here?

    • Intermediate-term inflation could stay stubbornly high (over 3%).
    • Economic growth could contract (recession), which would also lead to margin compression among corporations, and slowing earnings.
    • Housing could weaken materially.
    • Credit spreads could widen further.
    • Geopolitical concerns could expand (Ukraine war/China hostilities).
    • The world could experience another exogenous shock.

  5. What could go right from here?

    • Inflation/wage growth could begin to cool (last week’s rally in stock prices was tied to the fact that inflation, while still high, may have peaked).
    • Economic growth could slow, but remain positive, leading to a more favorable backdrop for corporate profits than is currently anticipated.
    • The housing market could remain firm due to low overall supply.
    • Credit spreads could remain contained.
    • Geopolitical tensions could cool (the Ukraine war could find a resolution, or China could accept foreign COVID-19 mRNA vaccines).
    • The world could experience a positive exogenous surprise.

Equity Takeaways:

Stocks fell in early trading on Monday. The S&P 500 dipped about 1%, with small caps down a similar amount. International developed market equities fell about 0.5%, however, emerging market equities rose about 2%, led by China.

The S&P 500 bounced strongly last week, rising over 6%, after falling for seven consecutive weeks. Sentiment was very bearish coming into last week, so a contrarian upside bounce was not shocking.

Market participants remain focused not only on inflation and Federal Reserve rate hike expectations, but also on credit spreads. Credit spreads tightened significantly last week, adding additional fuel to the rally in stocks.

The Institute for Supply Management (ISM) Prices Paid index remains quite high. It is typically tough for the stock market to bottom with significant price pressures remaining in the channel.

On the other side of the coin, S&P 500 aggregate corporate earnings have remained solid throughout the year. If earnings were to inflect lower, the stock market would likely come under further pressure.

In a typical midterm election year, June through August is typically very choppy and directionless. The year 1994, which shows many similarities to the current environment, also showed a choppy and directionless market over the summer.

The Russell indices will undergo their annual rebalancing/reconstitution over the next month. It is likely that we will see significant changes in the composition of the Russell indices during this timeframe.

Fixed Income Takeaways:

The Federal Reserve’s preferred method of inflation, the Personal Consumption Expenditures (PCE) Index, showed signs of decelerating in April. As inflation is showing signs of peaking, market participants are starting to believe that the Fed may slow down its rate-hiking efforts.

Despite the recent softening in some of the inflation data, recent comments from Federal Reserve governors (including comments this past weekend) have remained very hawkish and focused on controlling inflation. It is likely that the Fed will hike the Fed Funds rate by 50 basis points (0.50%) at each of their next two meetings (June and July). The current range for the Fed Funds rate is 0.75% - 1.00%.

The 2-year Treasury yield is very sensitive to Fed policy. The 2-year yield dropped about 9 basis points (bps) last week, as inflation expectations moderated. This morning, the 2-year yield rose 10 bps in early trading to 2.56%, reversing the drop of last week. 10-year yields also rose 10 bps in early Monday trading, to 2.85%.

Credit spreads have tightened significantly over the past week, in sympathy with the rally in equities. Much of the recent tightening in spreads can be attributed to reduced inflation expectations (and corresponding hopes that the Federal Reserve may not need to tighten policy as much as feared).

Quantitative Tightening (QT) is set to officially begin in early June. Effectively, the Fed will begin reducing the size of its balance sheet. On a net basis, QT will likely result in a reduction in overall financial asset liquidity (another form of tighter policy).

Municipal bonds showed significant outperformance last week, launching a strong rally that began on May 19. In just seven trading days, municipal bond yields dropped 50 bps. In the same timeframe, the 10-year Treasury note yield dropped 25 bps. Municipal bonds significantly outperformed Treasuries during this timeframe.

Despite stronger prices, municipal bond funds still saw outflows last week, to the tune of $1B. The pace of outflows has slowed, however.

According to Deutsche Bank, 2022 has seen the worst start to the year for US 10-year Treasuries since 1788!

General Takeaways:

  1. Bad news: the bear market may be entering a new phase.

    • The US Treasury yield curve has begun flattening once again, suggesting markets are beginning to worry less about inflation, and more about slowing growth.
    • Several large retailers reported earnings last week. Overall, topline revenue remained strong; but increased wage expenses, higher fuel costs and supply chain disruptions have all hurt margins. Too, with consumers facing increased food costs, their spending on other discretionary items has waned, causing inventory issues for several companies, which has also adversely impacted profitability.

  2. Good news: the inflation outlook may be entering a new phase.

    • The growth rate in average hourly earnings appears to have peaked.
    • Both 5-year and 10-year breakeven inflation rates turned lower in April. A breakeven inflation rate is a difference in yield between a nominal Treasury and an inflation-indexed Treasury of similar maturity.
    • Hints that tariffs being lowered could also ease inflationary pressures.

  3. Market volatility will persist; and the risks of a “financial accident” are elevated as financial conditions are tightening.

    • “Financial accidents” do not necessarily imply systemic risk but can lead to short/steep selloffs.
    • Recent extreme volatility in the cryptocurrency markets is one example.

  4. In this environment, avoid doing irreparable harm to your portfolio.

    • Focus on what you can control.
    • Know who you are; review your financial plan, asset allocation and risk tolerance.
    • Don’t panic sell and “hide in cash;” instead, rebalance and prune.

  5. Key Question of the week: is it too early to rebalance?

    • No, but as mentioned above, volatility will likely remain throughout the year.
    • Portfolios should be rebalanced regularly to ensure they are in line with your risk tolerance. Additional diversification in the form of alternatives or real assets should be considered where appropriate.
    • Be selective and disciplined, and don’t overreact to negative headlines.

  6. Investing advice for graduates.

    • Find an investment strategy that works for you.
    • Spend less than you make and be patient.
    • Save like a pessimist; invest like an optimist.
    • Stay invested throughout your lifetime to enjoy the power of compounding.
    • Nothing is as good or bad as it seems.

Equity Takeaways:

Last Friday saw a sharp selloff in the morning, followed by a rally in the afternoon. Monday morning, the S&P 500 continued late Friday’s bounce, rising about 0.5% in early trading. International shares were also higher, while small caps were flat to slightly lower.

Late last week, sentiment had reached extreme levels of bearishness. It is likely that the current rally is a tactical bounce due to oversold conditions, and that the selloff is not yet fully complete (a test of 3650 on the S&P 500 over the summer seems likely).

Last week was the seventh week in a row of declines on the S&P 500 – the last such occurrence was in 2001. The Dow Jones Industrial Average has seen eight consecutive declining weeks, the longest streak since 1923. Thus, the recent two months of a steady grind lower is a very rare historical pattern.

Corporate earnings are flattening but are still positive year/year. As noted above, many companies are reporting pressure on margins, but overall sales have remained strong.

There is a difference between an earnings recession and an economic recession. A corporate earnings recession (due to margin pressures) would likely put a cap on the equity market, but a further large downside might also be avoided. An economic recession would likely result in more stock market downside.

The 1994 analog could be appropriate for today’s market environment (steep selloff early in a mid-cycle election year), followed by a choppy, range-bound summer trading environment. In 1994, the market eventually bottomed after the November elections.

The S&P 500 has fallen close to 20% in 2022. Typically, if the economy can avoid a recession, a 20% drawdown is usually close to an interim bottom. Even if a recession does occur, forward 12-month returns after a 20% decline are generally positive.

Fixed Income Takeaways:

Longer-dated Treasuries rallied last week while the 2-year yield was essentially flat. As noted above, this flattening of the Treasury curve was likely caused by fears of slowing economic growth. In early Monday trading, the 2-year Treasury yielded 2.60%, while the 10-year Treasury yield was 2.82%.

Investment-grade (IG) corporate spreads have continued to steadily drift wider over the past few weeks and months. At 152 basis points (bps), IG spreads are now above the key 150 bps level. Spreads are now approaching levels that might cause the Federal Reserve (Fed) to pay closer attention to the smooth functioning of the credit markets.

During 2018’s “Fed mistake,” IG spreads reached 163 bps. In 2016’s China-led growth scare, IG spreads widened to 220 bps. Back in the 2011 Greek debt crisis, IG spreads were as wide as 272 basis points. The current level of 152 bps is still below these recent volatile episodes.

High-yield spreads have also continued to widen, with the most pronounced softness in the weakest credits (CCC-rated bonds).

General Takeaways:

  1. “There is no alternative” has been replaced by “nowhere to hide.”

    • All major asset classes within both equities and fixed income are down year-to-date (YTD). Through 5/13/22, the S&P 500 has dropped 15.1% YTD.
    • And while we expect volatility may likely persist, stocks are still the asset class of choice for compounding long-term wealth. In the last 10 years, the real return on bonds has barely kept up with inflation, and the yield on cash is still very low relative to inflation.

  2. Markets may be at a critical inflection point.

    • Corporate profits will hold the key – are we facing a “growth scare,” or something more nefarious?
    • Going forward, if the economy avoids a recession, stocks may stabilize soon. The median percentage decline during a market correction while the economy is expanding is 21%. The median duration of these “expansionary declines” is 6 months.
    • Conversely, during recessionary times, the median drop for the market is 32%, with a median duration of 17 months.
    • One significant tailwind for the economy: consumer balance sheets remain very strong. Household debt as a percentage of total income is much lower today than it was prior to the 2008-09 financial crisis.

  3. Inflation is showing signs of peaking.

    • The absolute level of inflation is still high, prompting the Federal Reserve (Fed) to continue its recent aggressive stance.
    • Last week, Chairman Jerome Powell summed up the Fed’s outlook in five words: “get inflation back under control.”

  4. Market volatility will remain persistent – the risks of a “financial accident” are elevated.

  5. In today’s environment, avoid doing irreparable harm.

    • Investors should focus on what they can control – know thyself.
    • This is a good environment for investors to review their long-term financial plan and asset allocation. Investors should avoid panicking to hide in cash – rather, rebalance as needed.

Equity Takeaways:

After strong gains last Friday that saw the S&P 500 rise over 2% and the Nasdaq 100 rise almost 4%, stocks dipped in early Monday trading. The S&P 500 fell about 0.75%, while the Nasdaq dipped about 1.25%. International stocks also fell.

Last Friday was the first 90% upside volume day on the New York Stock Exchange (NYSE) since late 2020. During market drawdowns, usually, it takes a cluster of 90% upside days before a bottom is formed.

Other indicators are also pointing to a short-term tactical rally. These indicators include: the Nasdaq is trading almost 20% below its 200-day moving average and put/call levels are very high (both indicating high levels of investor fear). The market is very oversold.

Another fear indicator - consumer sentiment has fallen to levels similar to the 2008-09 crisis. Going back to 1975, there have been eight major cycle troughs in consumer sentiment. The average forward 12-month returns on the S&P 500 after these cycle troughs have been over 20%.

A snapback rally could take the S&P 500 back towards 4200 from its current level of about 4000. It still appears that the market has some “unfinished business” to the downside. There are possible similarities to 1994 – a significant initial drawdown, then a choppy market into year-end, and culminating in a rally towards the end of the year.

Midterm election year seasonal patterns could also follow the 1994 analogy. During midterm election years, weakness typically occurs through the early fall, and the market usually rallies post-election.

Fixed Income Takeaways:

US Treasuries saw a flight to safety bid last week. 5-year Treasury yields fell about 16 basis points (bps) on the week, while 10-year Treasuries fell about 20 bps. Overall, the 2-year/10-year Treasury curve flattened by 11 bps.

In early Monday trading, the 10-year Treasury yield dropped 4 bps to 2.88%, while the 2-year Treasury yield was flat at 2.59%.

Market consensus is that the Fed is slated for several more consecutive 50-bps rate hikes. If this consensus is accurate, the Fed Funds rate will be nearing 2.0% by mid-summer, from its current level of 0.75% to 1.0%.

Credit spreads have continued to widen amidst the recent volatility and are now approaching 2018 levels. The move wider has been orderly.

Despite widening spreads, most corporate balance sheets are in good shape. Many corporations aggressively tapped the new issue markets in 2020-21 to lock in very low borrowing rates. Overall corporate leverage ratios, as well as interest rate coverage, are both at healthy levels.

Investors continued to pull money from investment-grade corporate bond funds last week – funds saw their fastest pace of outflows last week since April 2020.

Municipal bond yields rose 5-15 bps last week, even as Treasury yields dropped. The broad municipal index has dropped over 10% year-to-date, which is by far the worst start to a year in history (by over 4%).

Municipal bond funds have seen 18 consecutive weeks of outflows. Spreads remain under pressure due to these outflows. That said, after trading very richly for most of 2021, municipal yields relative to Treasuries are now at very attractive levels.

From a credit standpoint, most US municipalities are in very good shape, and several prominent states have received upgrades from rating agencies over the past month.

General Takeaways:

  1. The Federal Reserve (Fed) is sending confusing signals.

    • After the Fed’s meeting last Wednesday, May 4, during which they raised the Fed Funds rate by 0.50% to a range of 0.75% to 1.00%, stocks initially rallied almost 3%.

    • The next day, Thursday, May 5, stocks dropped an equally sharp amount.

    • Fed Chairman Jerome Powell’s messaging seemed to confuse market participants – more details are shared in the Fixed Income section below.

  2. The outlook for inflation is also perplexing.

    • Consumer Price Index (CPI) data will be released later this week, on Wednesday, May 11.

    • About one year ago (April 2021), inflation began to accelerate sharply. Thus, it seems possible that inflation could peak soon, although it is likely to remain elevated on an absolute basis.

    • Wage growth will be key to the economic outlook. The job openings report known as JOLTS, which shows available job openings per worker, could give clues on the forward outlook for wages.

  3. Outlook for economic growth is becoming more and more important.

    • According to the Institute for Supply Management (ISM), survey data continues to indicate the Eurozone and US economies are still growing solidly – China is the major exception.

    • That said, market participants are clearly worried that aggressive central policies could lead to a recession.

  4. Financial assets will continue to struggle to find direction.

    • The risk of a financial “accident” seems to be increasing, as many lending rates have risen sharply over the last six months.

    • Credit spreads are above pre-pandemic levels but are not showing signs of panic.

    • Corporate earnings momentum has begun to fade, which is another headwind for stock prices over the near term.

  5. KeyBank Investment Center has already made several portfolio adjustments.

    • On a long-term basis, we have never recommended “spec-tech” or unprofitable technology companies. We continue to favor quality companies throughout a full market cycle. We have also recently increased allocations to defensive sectors of the market.

    • Recently, we switched from an “overweight” equity recommendation to a “neutral” recommendation vs. our strategic long-term targets.

    • We continue to recommend the use of alternative and real asset strategies where appropriate, as a potential hedge against inflation.

  6. Investors who ride out the storm usually end up shining in the end.

    • As the old saying goes, “time in the market matters more than timing the market.”

Equity Takeaways:

Stocks opened lower in early Monday trading. The S&P 500 fell about 1.9%, while small caps fall about 1.5%. International shares also fell.


The market is acting like we’re in a bear market. Volatility will likely remain elevated over the short- term. The bias is to the downside until proven otherwise.


The S&P 500 has lost its upward trend. Breadth remains weak (few stocks rallying), and volume remains skewed to the downside as well – we are seeing more selling pressure than buying pressure.


Over the intermediate term, a traditional bear market has a 20-25% peak-to-trough decline. The worst bear markets (50%+) occur during sharp recessions or credit events. The current environment is not showing significant economic weakness, so a 50%+ bear market is likely off the table for now.


At its current level of about 4050, the current forward Price/Earnings multiple on the S&P 500 is about 17x. If the S&P 500 were to reprice towards 15x, it would result in a price target of 3500-3600. Some technical indicators are also pointing towards a fall into the mid-3000s on the S&P 500 index.


To this point, the selloff has been orderly. For example, implied volatility (VIX), while elevated, has not spiked above 36 during the April-May selloff. The current level of the VIX is about 33.


Fixed Income Takeaways:

The fixed income markets continue to price in an aggressive Fed rate hiking cycle. At 3.12%, current 10-year Treasury yields are the highest since late 2018.


Last week, Fed Chairman Powell said that a 75 basis-point rate hike (0.75%) was not considered for the May meeting. Fixed income market participants still believe that the Fed is significantly behind the curve with respect to controlling inflation and may effectively force the Fed’s hand.


Interestingly, the yield curve steepened significantly last week. The 2-year/10-year Treasury spread is now about 45 basis points. This is about 25 basis points wider on the week.


This week, the Treasury will be auctioning 3-year, 10-year and 30-year debt, which could put additional upward pressure on yields.


Corporate bond spreads were stable last week. Investment-grade (IG) spreads rose by only 1 basis point last week. All-in, IG corporate bond yields are now about 4.45% and continue to climb due to rising Treasury yields.


Many corporate bond issuers have already decided to postpone deals scheduled for this week due to Monday morning’s stock market volatility.


Investment-grade corporate bond funds saw $6B of outflows last week, representing week 11 out of 12 that saw outflows. Last week’s outflow was the largest outflow since the pandemic crash.


Both nominal and real Treasury yields have increased over the past several months. In a rising real yield environment, gold tends to struggle.

General Takeaways:

All types of financial assets are lower year-to-date (YTD) – details are listed below.. The most significant exceptions are “real assets,” such as commodities and real estate.

The top six reasons financial assets are falling:

  1. Post-pandemic boom spurred inflation.

  2. Policy actions (and inaction) fanned inflationary flames.

  3. Central banks are behind the curve and are now talking very tough.

  4. Stocks are “re-rating.”

    • Earnings continue to rise, but Price/Earnings multiples are falling because of inflation and the actions of the Federal Reserve (Fed).

  5. Crowded/concentrated markets are exacerbating the re-rating problem.

  6. War in Ukraine and China’s “zero COVID” policy are also putting upward pressure on inflation.

    • The Chinese and Eurozone economies are both quickly slowing.

* Out of the major concerns listed above, the geopolitical situation likely has the most potential to materially worsen over the next six months.

Searching for silver linings:

  1. 1st quarter 2022 US GDP was a mixed bag, but “core” economic growth is healthy, driven by continued substantial business investment and underlying consumer demand.

  2. Consumer spending is moderating, but compensation is booming.

    • Nominal wages and salaries rose 11.7% year/year in March.

    • Nominal consumer spending grew 9.1% (mostly price increases). Real consumer spending rose 2.3% year/year. A moderation of consumer spending could help cool inflation.

  3. The economy continues to reopen.

  4. Stock valuations are now less demanding.

  5. Credit spreads have widened but are not showing signs of panic.

  6. “The only thing we may have to cheer is fear itself.”

    • Investor sentiment is currently very bearish, which could eventually set the stage for a contrarian rally. Indeed, the most recent American Association of Individual Investors (AAII) survey showed a mere 18.9% bulls.

    • Since 1988, there have been 31 instances where the percentage of bulls in the AAII survey fell below 20%. Twelve months later, the S&P 500 was higher on 30/31 occasions, with a median return of 20.7%. The lone exception occurred in 2008.

Equity Takeaways:

After a sharp selloff of 3.6% last Friday, the S&P 500 opened essentially flat on Monday. Small caps rose slightly. International shares were mixed.

YTD through the end of April, the S&P 500 has dropped 12.9%, while small caps have fallen 16.7%. Developed international shares have essentially traded in line with the S&P 500 (down 11.7% YTD), despite a material slowing of the Eurozone economy.

There has been significant dispersion amongst underlying stock market factors. Growth stocks are down about 20% YTD, while value stocks are down about 5%. High-quality shares have dropped 12.5%, while low-quality stocks have dropped 17%.

Emerging market shares have also fallen, down 10.1%, driven by weakness in China (although Chinese shares have bounced back somewhat over the past week).

Fixed Income Takeaways:

This week, the Federal Reserve will likely raise the Fed Funds rate by at least 50 basis points on Wednesday, May 4th. The futures market is pricing in about a 50% chance of a 75 basis-point increase.

This Wednesday, Fed Chairman Jerome Powell will likely discuss front-loaded rate hikes at his press conference. Market participants will parse his words closely during and after this press conference.

Powell will likely also discuss Quantitative Tightening (QT) – the rolldown of securities from the Fed’s balance sheet.

Market participants are currently pricing in three consecutive 50 basis point rate hikes at the May, June, and July Fed meetings. The Fed Funds rate is expected to move above 2.0% by early 2023, from its current level of 0.25%.

Last week, US Treasury yields were relatively stable despite volatility in the equity markets. Early on Monday, the 10-year Treasury yield was 2.98%, while the 2-year Treasury yielded 2.71%.

Both investment-grade (IG) and high-yield bond spreads also continued to move wider laseek. The move wider remains orderly. Yields on IG-rated corporates are now at their highest levels since early 2019.

Weakness within IG paper was led by BBB-rated bonds, while CCC-rated bonds were the worst performers amongst high-yield debt.

New issue supply was muted last week, as many issuers chose to wait for market volatility to subside. Any new issuance this week will likely price on Monday or Tuesday before Wednesday’s Fed meeting.

General Takeaways:

  1. Inflation may be peaking, but there’s confusion beneath the surface.

    - In March, including food and energy, the Consumer Price Index (CPI) rose a “white hot” 1.24% month/month, and 8.56% year/year, reflecting energy price spikes.

    - That same month, Core CPI, which excludes food and energy, rose 0.32%, the slowest pace in 5 months. The year/year rate of change was 6.5%, almost exactly equal to February’s pace.

    - Inflation rose sharply beginning in March 2021, leading to “tough comparisons” for 2022. In other words, because inflation was growing quickly a year ago, the rate of change of growth in 2022 may begin to slow.

    - Used car prices are beginning to drop, falling 3.8% last month. Conversely, car & truck rental prices rose almost 12%.

    - Re-opening sectors, such as airlines and lodging, are seeing substantial price gains. Airfares rose 10.7% last month, while hotel/motel prices rose 3.7%.

    - The housing sector remains strong. Rent of a primary residence and owners’ equivalent rent rose 0.4% during the month for a year-over-year rate of 4.5%.

  2. Market-based and consumer-based inflation expectations are also confusing.

    - Breakeven inflation rates (as measured in the bond market) have moved well above the Federal Reserve’s 2% long-term target.

However, longer-term (3+ year) consumer inflation expectations have fallen in the past few months.

The bottom line: Inflation is likely to remain elevated even after peaking.

- Data such as Core CPI, freight rates, new & used car prices, pricing power surveys, and wage surveys all indicate that inflation is likely in the process of peaking.

- That said, inflation will likely remain strong (4%+) even after the peak.

- Inflation levels above 4% generally cause headwinds to stock prices (in the form of a contracting price/earnings index multiple). And as such, corporate earnings remain crucial and will be front and center in the near-term.

- See notes on the 2022 1st quarter earnings season below.

Longer-term: watch correlations among different types of assets.

- In the last two decades, stocks and bonds have generally been negatively correlated (bond prices rose as stocks fell, and vice versa). In the four decades prior, stock and bond prices were generally positively correlated.

- In recent months, stocks and bonds have once again become positively correlated. For example, the S&P 500 and high-quality core bond prices are down about 8% year-to-date in 2022.

- If inflation has moved into a secularly higher regime, bond prices and stock prices will likely move together, thereby providing investors with less diversification.

- For this reason, where appropriate, Key Private Bank continues to recommend an “underweight” position in bonds, supplemented by diversifiers such as Alternatives and Real Assets.

Equity Takeaways:

Stocks were mixed in early trading on Monday. The S&P 500 was essentially flat, while small caps dipped slightly. International shares were also fractionally lower.

The 2022 1st quarter earnings season kicks off this week in earnest, with 69 of the S&P 500 components scheduled to report. Thus far, with about 8.8% of companies reporting, about 74% of companies have beaten earnings expectations.

This earnings season, both value- and growth-oriented companies are delivering similar revenue growth in the 10-11% area; however, value stocks are outperforming on an earnings basis. Value stocks are being led by the energy and materials sectors.

Surprisingly, international companies have delivered stronger earnings growth than their US counterparts during this earnings season (albeit in a small sample size).

Equity market participants continue to watch the bond market. If longer-dated Treasury yields continue to move higher, they will remain a headwind for stocks, especially unprofitable technology companies.

Fixed Income Takeaways:

The US Treasury yield curve steepened last week. Two-year Treasury yields dropped 6 basis points (bps) on the week, while 10-year yields rose 13 basis points. In early Monday trading, 2-year yields drifted slightly higher to 2.48%, while the 10-year yield was flat at 2.83%.

After briefly inverting a few weeks ago, the 2-year / 10-year Treasury curve has re-steepened out to 35 bps, widening about 20 bps last week alone.

Investors continue to move up in quality within the corporate bond market. Within investment-grade (IG) corporates, BBB-rated issues are underperforming. Within high-yield corporates, CCC-rated issues are underperforming.

Negative mutual fund flows continue, with over $4 billion flowing out of high-yield bond funds last week. This outflow was the largest weekly outflow in several years. IG funds also continue to experience outflows.

Municipal bond funds have seen outflows in 13 of the last 14 weeks. Over $8 billion left the asset class last week, the fastest pace since April 2020. One minor positive is that the new issue calendar is light, which is limiting supply.

Leveraged loan funds, which are backed by floating-rate bonds, are one area of the bond market that has seen consistent inflows over the past several months.

General Takeaways:

The KeyBank Investment Center recently changed its asset allocation guidance and recommends slight reductions to risky asset positions, as late-cycle dynamics have emerged. Economic momentum is peaking, and financial conditions are tightening.

The KeyBank Investment Center has been “overweight” equities relative to bonds since early summer 2020. We now recommend a “neutral” stance on equities. Within equities, we are recommending a slight “overweight” to US equities relative to international shares.

Bonds are still “underweight” (but less so in some instances). We are now recommending slightly larger allocations to cash, alternatives and real assets (where appropriate). Slightly larger cash positions should help reduce overall portfolio duration.

We still do not expect a recession in 2022. Growth in the services sector of the economy is improving, even as demand for goods is waning. Corporate balance sheets are in strong shape, and the labor market is tight (as it usually is towards the end of the economic cycle).

Still, inflation has persisted, and the Federal Reserve is now sounding increasingly hawkish, suggesting that higher interest rates could result.

As late as August 2021, Federal Reserve (Fed) Chairman Jerome Powell stated that tighter monetary policy could be a “potentially harmful mistake.” In the short amount of time since, inflation has picked up significantly.

Current mentions of inflation as the nation’s most important problem are the highest Gallup has recorded since 1985. The Fed has significantly changed its rhetoric in response to this new data, becoming significantly more hawkish and focused on controlling inflation.

Forecasters expect overall inflation to peak in April 2022, however, readings are expected to stay elevated throughout 2022. Global food prices recently jumped 13% month/month, the most on record. Fed rate hikes can do little to dampen food inflation.

Equity Takeaways:

US stocks fell in early trading on Monday. The S&P 500 dropped about 0.75%, while the Nasdaq fell about 1.25%. International shares were generally lower.

With 10-year yields continuing to move higher, the tech-heavy, longer-duration Nasdaq was underperforming other equity indices in early Monday trading. As longer-term rates rise, certain types of unprofitable technology companies tend to be hurt the most.

First quarter 2022 earnings season is set to kick-off, and it’s an important one. Due to the omicron variant, as well as the war in Ukraine, first quarter 2022 earnings estimates have been lowered over the past several months, perhaps setting the stage for upside beats.

Forward guidance will likely be even more important, as investors continue to grapple with the effects of inflation on corporate demand and profit margins. Continued strength in corporate earnings will be required to support the stock market going forward.

Earnings in the energy sector are set to vastly outperform other sectors of the market, however, energy shares remain a relatively small component of the S&P 500 index.

Certain cyclical sectors (commodities/energy), as well as quality companies with a growth bias (healthcare/technology), could receive more attention from investors as demand for goods slows. Over the past several weeks, trucking company shares have fallen significantly – this type of movement often foreshadows slowing industrial demand.

Buyback activity slowed over the last quarter. Company management teams now seem to be more focused on shoring up their balance sheets.

Fixed Income Takeaways:

The 10-year Treasury yield continues to increase, resulting in a steeper yield curve over the past week. 10-year Treasuries yielded 2.76% in early Monday trading, while 2-year Treasuries yielded 2.55%. 10-year yields have risen about 35 basis points (bps) in the last week.

Market participants are now expecting 50 bps rate hikes at both the May and June Federal Reserve meetings. We expect the Fed to match these expectations. Overall, the Fed Funds rate is expected to close 2022 between 2.0% and 2.25% (from its current level of 0.25%).

Recently, details about the reduction of the Federal Reserve’s balance sheet (e.g. Quantitative Tightening) have been released. The Fed’s plan involves an aggressive reduction in the total size of the balance sheet, which is another form of tighter policy designed to help control inflation.

New investment-grade (IG) corporate bond issuance remains robust, with over $25 billion of deals pricing last week. About 55% of these new deals came from companies in the financial services sector.

IG corporate bond funds have seen 13 consecutive weeks of outflows, representing a continued headwind to prices. Municipal bond funds also continue to experience outflows.

High-yield spreads have widened throughout 2022, however, the move has been orderly. Spreads are not yet to levels that will drive significant new investor interest – spreads are also not currently reflecting levels of high economic stress.

General Takeaways:

Key Takeaways – take me out to the ballgame edition:

  1. The US economic expansion may be in the bottom of the seventh, but extra innings are possible.

    • The Federal Reserve (Fed) is hawkish, led by Chairman Jay Powell. Powell remains optimistic about a soft landing in the economy.
    • Strength in the job market remains a bright light. Non-farm payroll employment rose another 431,000 in March, plus upward revisions for February; but total employment remains 1.8 million jobs below the pre-COVID peak.
    • Importantly, the labor market participation rate continues to increase, but remains below levels seen before the COVID-19 pandemic, implying room for continued improvement.
  2. The bull market in US stocks may be in the top of the seventh, but extra innings are possible here too.

    • Corporate earnings estimates have continued to trend higher, which should help continue to support stock prices.
    • The upcoming 1Q:2022 earnings season will give us more information about the impact of inflation and the war in Ukraine on corporate profits.
  3. The bear market in bonds may be at the top of the eighth.

    • The current yield on the 10-year US Treasury is 2.42%. Should 10-year Treasury yields reach 3.00%, that level could be a tipping point.

Bottom Line:

  • Deciding what to own in this environment is extremely challenging and is a game of “relatives” vs. “absolutes.”
  • Stocks are attractive relative to bonds and cash, and better protect a portfolio from inflation. Real assets offer some diversification but need to be sized appropriately given their inherent volatility.
  • COVID-19 remains a problematic wild card, as the case count continues to increase in China.
  • High-quality issues are preferred across all asset classes. Investors should stay selective and be conscious of entry points.


Equity Takeaways:

Stocks were mixed in early Monday trading. The S&P 500 rose about 0.4%, while small caps fell 0.7%. International shares were generally higher.

As recently as mid-March, the S&P 500 was down between 12-13% year-to-date (YTD), but rallied in the last few weeks of March to reduce the overall decline to 4.6% for 1Q:2022. Trading was very choppy. According to Bloomberg data, as cited by the Motley Fool, 1Q:2022 saw 35 negative trading days for the S&P 500, the most for any first quarter since 1984.

Growth stocks dropped 8.7% in the quarter and significantly underperformed value stocks, which fell only 0.2% in 1Q:2022. Value stocks were led by the energy sector, which shot higher by 39% in the quarter.

In the coming weeks, the focus of market participants will shift to corporate earnings. Company guidance will be key to the future trajectory of the market. Guidance revisions have been trending weaker in the past several quarters – we will likely need to see this trend reverse for the market to continue higher over the near-term.

Fixed Income Takeaways:

Last week, long-end Treasury yields fell 5-15 basis points (bps), while front-end rates continued to rise. That dynamic reversed slightly in early Monday trading, with 10-year yields rising 4 bps to 2.42%, while 2-year yields remained stable at 2.46%.

Market expectations are for significant, frontloaded interest rate hikes in 2022. The Fed Funds rate is expected to close the year between 2.00% and 2.25% (from its current level of 0.25%). Individual hikes of 50 bps each (0.50%) are expected in the coming months.

Fixed income yields rose significantly in 1Q:2022, with spreads widening as Treasury yields rose. The 2-year Treasury yield rose an astounding 158 bps in the quarter, while 10-year yields rose 82 bps. High-quality municipal bond spreads widened 24 bps during the quarter, investment-grade (IG) corporate bond spreads rose 26 bps, and high-yield spreads rose 41 bps.

IG credit spreads regained some ground last week, tightening by 9 bps, led by BBB-rated issuers. High-yield spreads tightened by 11 bps, led by CCC-rated issuers. Even as Treasury yields rose throughout the past month, new issuance levels remained very high in March.

Since their peak, intermediate-term high-quality bond prices have fallen over 8%, the worst drawdown in 30 years. Long-term bonds have fallen even more and are experiencing their worst peak-to-trough drawdown in over 50 years.

Two different yield curves are telling different stories. The often-cited 2-year / 10-year Treasury spread inverted slightly last week, possibly indicating a slowing economy. That said, the 3-month / 10-year spread remains solidly positive, indicating continued expansion. In a recent paper, the Fed noted that it is not concerned with the shape of the 2-year / 10-year curve, noting that its inversion could be caused by many factors.

Four major points about yield curves:

  1. Not all yield curves are giving the same message (see above).
  2. Curves need to remain inverted for a while before becoming worrisome.
  3. Inverted curves have been good forecasters of eventual recession, but not necessarily the timing of a recession (6-18 month lead time).
  4. Stocks have historically rallied/stayed positive during inverted curves before a recession emerges.

Bottom line:

Key Private Bank generally recommends moving up in quality within fixed income, as well as a slightly shorter portfolio duration compared to the index. Floating-rate securities can also provide important diversification in this environment.

General Takeaways:

  1. The Federal Reserve (Fed) updated its long-term forecasts.

    • Fed governors are sounding more hawkish (more willing to raise interest rates to combat inflation).
    • One year ago, the Fed predicted that Personal Consumption Expenditures (PCE) inflation would rise 2.0% in 2022. In March of this year, they increased their forecast to 4.3% PCE inflation in 2022. Inflation is expected to moderate in 2023.
    • The Fed now predicts that the Fed Funds Rate will rise to 1.9% in 2022, and 2.8% in 2023, from its current level of 0.33% [range of 0.25%-0.50%].
    • Economic growth is projected to rise by 2.8% in 2022 (down from a projection of 4.0% growth made several months ago) and 2.2% in 2023.
  2. Fed Chairman Jay Powell’s comments were interpreted as hawkish.

    • Powell’s comments last week were very focused on controlling inflation, but he is optimistic that the US economy will achieve a “soft landing,” with slowing growth accompanied by continued strength in the labor market (no recession is predicted).
    • Powell essentially acknowledged that the Fed has been behind the curve with its inflation response. He implied that individual rate hikes of 50 basis points (0.50%) are possible, instead of the normal/historical 25 basis points (bps).
  3. The Fed’s past record of achieving soft landings in the economy has not been great.

    • In 1994, The Fed Funds Rate was increased from 3% to 6% within 13 months. At the same time, the unemployment rate fell from 6.6% to 5.4%, and the economy avoided recession.
    • However, the rate-hiking cycles that began in 1999 and 2004 did not achieve similar results, with the economy falling into recession after the Fed completed raising rates. Yet, there were also other factors contributing to the recessions in each period.
    • The outlook for inflation is incredibly uncertain. COVID-19 cases, while currently contained in the US, are rising overseas, which could put a damper on global economic growth.
  4. US economy still has considerable momentum.

    • Corporate earnings remain a bright spot. Forward earnings estimates continue to be revised higher.
    • The labor market remains tight. The unemployment rate dropped to 3.8% in February – the Fed expects unemployment to fall to 3.5% by the end of 2022. That said, unemployment is a lagging indicator. Weekly initial unemployment claims (a leading indicator) remain at a 52-year low and are currently below the average pre-pandemic level.
  5. Other economic indicators are mixed.

    • For example, two different yield curves are sending conflicting signals. Historically, yield curve inversions (shorter-dated yields being higher than longer-dated yields) have foreshadowed slowdowns in the economy.
    • The spread between the 2-year and 10-year Treasury has narrowed to very tight levels. Early on Monday, the 2-year Treasury yield was 2.32%, while the 10-year Treasury yield was 2.46%. Therefore, the spread of 14 bps between the two yields provides only a narrow margin before the curve becomes “flat” and then potentially “inverted.”
    • The spread between the 3-month Treasury bill and 10-year note, however, has remained at wide levels. The 3-month yield was 0.54% in early Monday trading, resulting in a 3-month / 10-year spread of 192 bps.
    • We are inclined to remain overweight on equities relative to bonds while the 3-month / 10-year Treasury curve remains steep. The New York Fed uses the 3-month / 10-year spread as a leading indicator in a recession probability model.

Bottom Line:

  • Deciding which assets to own in this environment is extremely challenging and is a game of “relatives” vs. “absolutes.”
  • Stocks remain attractive relative to bonds and cash, providing better protection against inflation.
  • Real assets offer some diversification but need to be sized appropriately given their volatility profile.
  • High-quality issues are recommended across all asset types – stay selective and be conscious of entry points.
  • The war in Ukraine, as well as COVID-19, will both continue to affect the forward outlook in an uncertain fashion.

Equity Takeaways:

Stocks were mixed in early Monday trading. The S&P 500 was essentially flat, while the tech-heavy Nasdaq rose slightly. Small caps fell about 0.75%. International shares were also mixed.

Even equity market participants are focused on bond yields these days. The recent sharp move higher in the 10-year Treasury note yield could soon become a headwind to equity prices. If the 10-year note yield were to approach 3.0% from its current level of about 2.5%, the pressure on equities could increase.

During the past two weeks, the S&P 500 has risen over 8%. Typically, after such a move, the market will need some time to digest gains.

The upcoming 1Q:2022 earnings season, which begins in about 10 days, will be very important. Forward guidance will likely be the most important factor to drive the market.

Fixed Income Takeaways:

Last week, Treasuries sold off significantly after Fed Chairman Powell’s comments. Market participants now expect a 50 bps rate hike at both the upcoming May and June Fed meetings.

Market expectations are for the Fed Funds rate to rise towards 2.0% in 2022. As a result of these increasingly hawkish expectations, both 2-year and 10-year Treasury note yields rose by over 30 bps last week.

Fixed income assets have experienced large drawdowns in recent months. Since the recent peak, intermediate-term bonds have fallen over 8%, which is the worst drawdown in 30 years.

The US Treasury will be auctioning both 2-year and 5-year Treasury notes on Monday. Investor demand for this auction will be an important signal as to the near-term direction of yields.

Investment-grade (IG) spreads were about 4 bps tighter last week, while high-yield spreads were about 12 bps tighter last week. New corporate bond issuance remains heavy, with institutional investors stepping in to purchase bonds at these higher yields.

Municipal bond yields (1-5 year part of the curve) rose 30-35 bps last week. Month-to-date, front-end municipal yields have risen 60-65 bps. The 5-year municipal bond index has dropped over 5% year-to-date (YTD).

Liquidity has been poor in municipals. Negative fund flows continue, which continues to put pressure on the asset class. Luckily, the new issue calendar has been light.

General Takeaways:

Four Key Takeaways

  1. Ukraine Situation Continues to Worsen

    • 10 million people have fled to other countries.
    • President Biden will attend a summit of the North Atlantic Treaty Organization (NATO) in Brussels this week.
    • The war has impacted global supplies of food, fuel, industrial metals, and fertilizer. For example, Brazil imports about 85% of its fertilizer, and a significant amount of those imports come from Russia.
    • 15% of the world’s calories come from wheat, while a third of the world’s wheat is grown in Ukraine and Russia. 25% of the world’s exported wheat comes from this region.
    • The world operates on a 90-day food supply. Poorer countries are likely to suffer greatly in the coming months, which could cause additional global political instability.
  2. COVID-19

    • Indicators of activity/mobility continue to improve. Despite news that another variant may exist, survey data indicates that consumers are much more comfortable attending sporting events, going out for dinner or a movie, etc.
  3. Economy Remains Relatively Strong

    • Nominal retail sales rose 18% year/year in February (real retail sales were up 7%, while prices rose 11%). Nominal industrial production surged 24% year/year in February (prices rose 17%, while real industrial production rose 7%).
    • US housing starts made a new high in February, and the labor market continues to show strength.
    • Despite these strong current numbers, recession risk is likely increasing. The yield curve continues to flatten – an inverted yield curve tends to be a strong indicator of a future recession.
    • The NY Federal Reserve has run a recession probability model for many years. This NY Fed model currently shows only a 10% chance of a recession within the next 12 months. Going back to 1962, this indicator has touched at least 30% prior to each subsequent recession. The NY Fed model output can change with new information, and we will continue to watch for updates. Key Private Bank’s assessment is that the probability of a recession is somewhere between 10% and 25%, based on current data.
  4. US Federal Reserve (Fed) Policy

    • The Fed is now officially in a tightening cycle, having raised the Fed Funds rate by 25 basis points (from a target range of 0.00%-0.25% to a target range of 0.25%-0.50%) last week.
    • The pace of rate hikes will be data-dependent. Quantitative Tightening (QT) is on the table for May.


  • As noted on recent calls, we believe investors should revisit Real Asset strategies as a hedge against inflation. Due to increased recent yields, bonds are an increasingly viable hedge as well.
  • Long-term investors should stick with stocks but be selective and conscious of entry points over the near term. Stocks remain one of the best ways to grow and compound wealth over long time horizons.

Equity Takeaways:

US stocks were slightly lower in early Monday trading. The S&P 500 fell about 0.1%, with small caps also fractionally lower. The tech-heavy Nasdaq dropped about 0.5%. International shares were mixed.

As of Friday’s close (3/18/22), the S&P had rallied four consecutive days, closing about 6% higher on the week. Typically, after a strong weekly performance, the next week has a positive bias.

Implied volatility (VIX) dropped significantly last week. The VIX traded over 37 on March 8. During the recent rally in stocks, the VIX quickly dropped and was trading at 24.5 early on Monday.

Recall our comment from March 7:

Key Private Bank recently studied VIX spikes and subsequent market returns. Going back to 1990, there were 310 daily instances when the VIX traded at 36 or higher. Twelve months later, the S&P 500 was higher 96% of the time.

Fixed Income Takeaways:

Treasury yields moved higher last week in response to Fed Chairman Powell’s comments on Wednesday. 10-year Treasury yields rose 16 basis points (bps) last week and have risen over 40 bps year-to-date (YTD).

In early Monday trading, yields were rising again across the curve. The 10-year Treasury yield was 2.24%, while the 2-year Treasury yield rose to 2.02%.

Chairman Powell emphasized price stability as his main message, leading many market participants to view the meeting as a hawkish surprise. The Fed’s inflation expectations were revised significantly higher, while growth expectations were revised lower.

Market expectations are for 7 total rate hikes of 25 bps each in 2022, which would bring the Fed Funds rate to a target range of 1.75%-2.00% by the end of the year. Further rate hikes are expected in 2023. The expected terminal Fed Funds rate is 2.80%.

Certain portions of the yield curve have already inverted (7-year to 10-year spread is now negative); however, this portion of the curve is not typically viewed as a recession indicator.

Investment-grade (IG) corporate bond spreads tightened 13 bps last week in tandem with rising equities. High-yield spreads also tightened last week, despite a tenth consecutive week of mutual fund outflows in the sector.

Overall yields have risen significantly this year, leading some bond investors to buy the dip. Bond investors are focused on high-quality, liquid issuers.

Broad emerging market bond indices dropped almost 10% after the invasion of Ukraine, but most bottomed around March 7 and have been rising ever since. Russia made good on its dollar-denominated bond payment last week. Ukrainian bonds have held up remarkably well, with most investors believing they will be paid close to par.

General Takeaways:

  1. Ukraine – signs of hope and signs of concern.

    • China is a hugely important actor – a closer alliance between Russia and China would have large global implications but at the same time, China appears to favor geopolitical stability and has much more at stake than Russia does on the world’s stage. Thus, they will likely try and remain as neutral as possible, for as long as possible, while also potentially acknowledging that they alone can influence the ultimate outcome of this situation.
    • On the positive side, some progress on a framework for a possible deal seems to have been made in the past several days, but such progress is still very fragile with both sides far apart.
    • On the negative side, recent Russian missile strikes have moved closer to the Ukrainian / Polish border (Poland is a member of the North Atlantic Treaty Organization – NATO).

  2. Inflation – accelerating and broadening.

    • The headline Consumer Price Index (CPI) rose 7.9% in February. The Core CPI rose 6.4%. Both figures represent an acceleration from January (albeit in line with market expectations).
    • The rate of change of core inflation growth declined in February vs. January; however, the February inflation numbers generally reflected data collected prior to Russia’s invasion of Ukraine, suggesting inflation will remain and could possibly accelerate further in March.
    • The situation is not yet akin to the 1970s, as longer-term inflation expectations have remained generally stable at around 3%. In the current environment, core CPI services data has also remained relatively contained, while commodity prices are spiking. In other words, inflation today is not as widespread as it was in the past.
    • Wheat might be the most important commodity. Russia and Ukraine combined account for about 25-30% of the world’s supply of wheat. This supply is now under significant strain, which could have broad implications for the global food stock.
    • Tariffs with China: this July is the fourth anniversary of the $350 billion in Section 301 tariffs currently being imposed on Chinese imports. By law, after four years, such tariffs must undergo a Congressionally mandated review, or they expire. Most pundits expect an eventual rollback of tariffs on some consumer goods, combined with higher tariffs on a narrower set of strategic sectors (steel, solar, semiconductors, batteries, etc.). Progress won’t be a straight line, but if tariffs are reduced, it could help mitigate inflationary pressures all else equal.

  3. The US Federal Reserve (Fed) will likely begin a new tightening cycle at their March 16 meeting.

    • Full recovery in the US labor market has seemingly been achieved (the total number of jobs lost in the COVID-19 recession has been recovered).
    • The Fed will likely be tightening into a slowing economy. Wage growth seems to have flattened out, and consumer confidence remains low reflective of recent spikes in inflation.
  4. COVID-19 is still affecting global supply chains.

    • As one example – China’s tech hub, Shenzhen, locked down 17.5M residents. Shenzhen is an important manufacturing center for Apple.
  5. In summation, US recession risks are rising.

    • We recommend that clients revisit our recommended Real Asset strategies as a hedge against inflation.
    • Bond yields have risen somewhat recently and increasing coupon yields makes them more attractive as a possible hedge.
    • Long-term investors should stick with stocks (but be selective and be conscious of entry points in the near-term).

Equity Takeaways:

Stocks were mixed in early Monday trading. The S&P 500 rose about 0.25%, while both small caps and the Nasdaq 100 were fractionally lower. International shares were mixed.

The S&P 500 is currently sitting on the neckline of a potential “head and shoulders” topping formation, making the current area an important level of support.

Last week, the S&P 500 dropped 2.9%. Typically, the week after a drop of over 2%, the market will attempt to bounce. The sentiment is also very negative (market participants are very bearish), which can also help set up contrarian bounces.

Even though the S&P 500 dropped over 2% last week, implied volatility (VIX) also fell over 2%. It is very rare to see both the VIX and S&P 500 fall over 2% during the same week. The VIX was trading at 30.9 early on Monday.

This Friday (3/18) is “triple witching” day, on which stock market index futures, stock market index options, and individual stock options will all expire. Volatility tends to increase around these dates.

Fixed Income Takeaways:

This week, the Fed’s primary focus will likely be on containing inflation. The European Central Bank (ECB) gave a similar message last week.

Market expectations for rate hikes have increased once again in the past week. Shortly after Russia’s invasion of Ukraine, market expectations dropped to about four total rate hikes of 25 basis points (bps) each in 2022. Currently, market participants expect seven rate hikes of 25 basis points each in 2022, which would put the Fed Funds rate at 1.75% (target range of 1.75%-2.00%) by the end of 2022.

Last week, US Treasury yields rose significantly, with both 3-year and 5-year Treasury yields rising 31 basis points. Yields rose again in early Monday trading, with the 5-year Treasury yield topping 2.0% for the first time since 2018.

Longer-term yields have risen less than short-term yields, with longer-term yields likely reflecting concerns about future economic growth. Currently, the slope between the 5-year and the 10-year Treasury yield is only 5 basis points, and the slope between the 2-year and 10-year Treasury yield is only 27 basis points.

Last week, investment-grade (IG) credit spreads rose 13 basis points, to 143 basis points. High-yield spreads widened 18 basis points. Even after the recent widening, credit spreads remain within long-term averages. Spreads have not risen to levels that might cause concern for the Fed.

Municipal bonds have remained under pressure throughout 2022. Municipal bond funds have seen outflows in nine consecutive weeks, averaging $1.8 billion per week (in stark contrast to the inflows seen throughout 2021).

Lower levels of new issuance, combined with these negative fund flows, have cheapened municipals relative to treasuries. At current levels, municipal yields have returned to fair value vs. treasuries. A 1-year municipal bond now yields slightly above 1%.

General Takeaways:

Five Takeaways

  1. The Ukrainian/Russian situation will have profound short-term and long-term implications. In a previous briefing, we wrote: “This situation is fraught with far greater geopolitical risks than other crises. Such risks are hard to predict and manage."

    • In the last several days, the Biden administration has floated the idea of a Russian oil embargo. Thus far, European support for an oil embargo seems limited, but the price of oil has spiked, nevertheless.

  2. Short-term (3-6 months):

    • Expect volatility as the Russian economy collapses, Europe enters a sharp slowdown (a recession in Europe is possible), and US growth slows.

  3. Long-term (12+ months):

    • Expect greater geopolitical instability and a renewed focus on Russia’s place on the global stage. The world will also reassess the global energy supply chain.

    • It is hard to envision exactly how the United States and China will respond to this crisis. Tariff negotiations are scheduled to begin between the US and China within the next several months, adding another layer of complexity.

  4. The US Federal Reserve (Fed) will go forward with its plan to increase interest rates, but flexibility will likely be required as the year evolves.

    • Market expectations are currently for 5 to 6 Fed Funds rate hikes of 25 basis points each in the calendar year 2022.

  5. Stocks are still the best asset for growing and compounding wealth over the long run.

    • Be selective, be patient, and be conscious of your entry points.


Sanctions on Russia – Details:

  1. Removal from SWIFT (restricts banking transactions).

  2. Restrictions on Russian Central Bank (hard to access reserves to support its currency).

    - The Russian Ruble has fallen in value precipitously, and Russian equities have collapsed.

    - Russia had “de-dollarized” its financial reserves by moving assets to Europe, China, and into gold. A significant portion of those reserves are now inaccessible.

  3. Russian banks cut off from US dollars.

  4. Nord Stream 2 pipeline project suspended (direct natural gas line from Russia to Germany).

  5. UK financial restrictions (limits on exports).

  6. US tech supply (limits on exports).

  7. Canadian sanctions (targets on individuals and banks).

  8. Airspace bans (US, EU, UK closed airspace access to Russia).

  9. Many individual companies across a wide variety of sectors have taken actions on their own.


Russian and Ukrainian Economy – Quick Notes:

  • Russian GDP growth had averaged 6.8% annually from 1999-2008 but slowed to an average of 1.5% per year from 2010-2021.
  • Declining population, poor diversification, corruption, and heavy government control are all structural issues within the Russian economy.
  • Russia’s exports are concentrated in energy and natural resources. The impact on the fertilizer market is also causing wheat prices to spike.
  • On a combined basis, the Russian and Ukrainian economies account for about 3.3% of global GDP.


The US labor market continues to improve.

  • US non-farm payrolls increased by 678,000 in February, vs. expectations of an increase of 440,000.
  • The labor force participation rate also continued to show improvement, indicating that US workers are returning to the labor force.
  • Wage growth remains robust. Average hourly earnings increased 5.1% year/year in February. That said, the monthly rate of change was flat.

Equity Takeaways

Overnight, S&P 500 futures traded down by as much as 2% but recouped some of their losses prior to the Monday open. The S&P 500 dropped about 1% in early Monday trading, while small caps were fractionally lower. International shares remained under heavy pressure.

Last week, despite all the negative news, the S&P 500 dropped only about 1.25%. European shares faced much heavier pressure, generally dropping 6-10% on the week.

1Q: 2022 earnings season was strong on balance, with overall profits continuing to improve. The recent selloff in equities has resulted in contracting Price/Earnings multiples.

With 99% of S&P 500 companies reporting, 75% of companies beat Wall Street’s earnings estimates for 1Q:2022, another solid showing. In 4Q:2021, about 80% of companies beat expectations.

Implied volatility (VIX) was 33.8 in early Monday trading, vs. the long-term average of 19.4. Spikes in the VIX generally indicate increased fear in the marketplace.

Key Private Bank recently studied VIX spikes and subsequent market returns. Going back to 1990, there were 310 daily instances when the VIX traded at 36 or higher. 12 months later, the S&P 500 was higher 96% of the time.

Fixed Income Takeaways:

The 10-year Treasury yield dropped about 23 basis points (bps) last week, to close the week at 1.73%, its lowest closing level since January. Yields drifted slightly higher in early Monday trading.

Investment-grade (IG) corporate bond spreads widened by 11 bps last week. BBB-rated paper widened 15 bps. Spread widening has been especially pronounced in European financials.

High-yield corporate bond spreads widened 28 basis points last week but remains under 400 bps on an option-adjusted basis. These levels indicate caution, but not distress.

Despite widening spreads, overall corporate bond yield levels remain low due to dropping Treasury yields. As a result, new issuance levels remain robust. On balance, widening corporate bond spreads indicate caution, but market participants are not showing panic.

Next week, the Fed is expected to raise the Fed Funds rate by 25 basis points at their March meeting. This will be the initial rate hike of the upcoming cycle. As noted above, market participants are expecting five to six rate hikes in 2022.

General Takeaways:

  1. Markets hate uncertainty and we have it on multiple fronts.

  2. The economy (excluding Ukraine) is on solid footing, but in transition.

    • Volatility was a key theme for 2022, and we’re getting it.

  3. The Ukraine situation may cause the US Federal Reserve to slow its pace of raising interest rates.

    • We do not expect the Federal Reserve to completely halt rate increases due to the current geopolitical uncertainty.
    • Federal Reserve (Fed) Chairman Jerome Powell will give his semi-annual testimony to the House and Senate this coming Wednesday and Thursday, respectively. He is expected to endorse a policy of gradual interest rate increases. More details are in the “Fixed Income” section below.

  4. The current situation is fraught with far greater geopolitical risks than other recent crises.

    • These types of risks are very hard to manage and mitigate.
    • Bonds can be a reasonable hedge in this environment, but because interest rates are already quite low, they may not offer the same amount of diversification versus past “risk-off” events.

  5. Stocks remain the best asset for growing and compounding wealth in the long run, but more volatility is likely in the weeks ahead.

    • Key Private Bank continues to favor high-quality cyclicals and remains overweight high-quality companies in client portfolios.
    • We also continue to recommend Real Asset / Real Estate exposure in client accounts where appropriate, for additional diversification and protection against inflation.
    • Structured notes, such as buffered or drawdown notes, are additional tools Key Private Bank uses to provide equity-like upside with downside protection during volatile market environments.
    • Cryptocurrencies, such as bitcoin, have behaved more like risky assets than hedging assets during the recent market volatility. The reference by some industry supporters that bitcoin is similar to “digital gold” has not held up during this volatility.

Three Major Risks – The Three “Ps”

  1. Powell (Federal Reserve Chairman Jerome Powell) – What will he say this week?

    • The Federal Reserve is likely behind the curve in its response to inflation and will thus likely continue to raise rates despite recent geopolitical events.
    • With Russia’s recent invasion of Ukraine, the situation regarding inflation has become even more complicated due to rising energy prices and the prospect of slowing economic growth.
    • We continue to believe that core inflation will remain above the Fed’s target of roughly 2% but likely will subside over time as supply bottlenecks ease and labor markets normalize.
    • Rising energy prices will boost inflation, but the US is significantly less reliant on imported energy compared to previous inflationary periods like in the 1970s.
    • Innovation continues to boost productivity, which is another reason long-run inflation should remain relatively contained.

  2. Putin (Vladimir)

    • Russia’s major escalation of the conflict in Ukraine has caused turmoil in global markets.
    • Putin’s goal is likely to prevent Ukraine’s ultimate entry into the North Atlantic Treaty Organization (NATO).
    • Russia represents less than 1.5% of total US exports and less than 1.5% of total US imports. That said, Russia is a major global exporter of energy, fertilizer, etc.
    • Russia represents less than 3% of emerging market indexes, so the direct impact on investment portfolios is likely to be relatively small. The risk of contagion, however, needs to be monitored.
    • Indeed, the Russian Ruble has come under significant pressure in the last week. On Monday, the Russian Central Bank raised interest rates to 20%.
    • Depending on the exact nature of the sanctions imposed on Russia, the possible range of global outcomes is large. Currently, some disruption of Russian oil and gas exports seems likely, which will cause increased inflation, especially in Europe.
    • A full shutdown of Russian oil and gas exports would likely have significant negative ramifications for economies around the globe.

  3. Pandemic

    • In the US, the rolling 7-day average of COVID-19 cases has plunged from over 800k to under 100k in just five weeks.
    • As cases have plunged, the economy has reaccelerated. For example, restaurants have seen a noticeable pickup in activity.

Equity Takeaways:

S&P 500 futures initially traded about 2.5% lower last night but rebounded somewhat before the Monday open. In early Monday trading, the S&P 500 dropped about 1.0% in volatile trading. Small caps dipped about 0.5%. International shares also fell, with European shares especially weak.

Typically, bottoming patterns occur with at least one “90% downside day,” where essentially all stocks drop. In the recent selloff, we have not seen a 90% downside day, perhaps indicating that sentiment has not reached rock bottom yet.

The transition back to a world with multiple global powers (also known as a multi-polar world) could result in higher geopolitical risk in the coming years. Stock earnings multiples tend to compress in such an environment.

Put another way, the last 20 years of relative global peace have likely supported higher stock valuations.

Fixed Income Takeaways:

US Treasury yields dropped in early Monday trading in a flight to safety. The 10-year Treasury yield dropped 10 basis points, to 1.87%. Last week, the Treasury market experienced wide swings, with yields rising and falling in response to global events.

Overall, while corporate credit spreads widened somewhat last week, trading has remained relatively orderly. There was no additional new investment-grade (IG) corporate bond issuance on either Thursday or Friday. Lower supply tends to support spreads.

On Friday, high-yield credit spreads tightened, closing 8 basis points tighter on the week. That said, high-yield spreads have still widened 50 basis points year-to-date (YTD).

The chances of a 50 basis-point Fed Funds Rate hike at the Fed’s March meeting continue to drop due to the events in Ukraine. A 25 basis-point hike remains fully priced in. The March Federal Open Market Committee (FOMC) meeting is now less than three weeks away, on March 16.

On Wednesday and Thursday, Fed Chairman Powell will give his semi-annual testimony to the House and Senate respectively. This communication will likely be Powell’s final public appearance before the March 16th FOMC meeting.

Powell is expected to endorse a gradual course of interest rate increases, likely with an initial 25 basis-point hike. The bulk of FOMC governors seem to support this view.

General Takeaways:

  1. The "Four Ps" are drawing investors’ attention. 
    • Pandemic: mobility metrics indicate that consumers are getting out more and learning to live with COVID.
    • Powell, Jerome: Federal Reserve (Fed) policy remains uncertain but poised to become more restrictive.
    • Putin, Vladimir: an increasing number of signs are pointing to a Russian invasion of Ukraine.
    • Profits: the economy is still booming, and many companies have reported strong pricing power.

  2. The US Federal Reserve is under pressure. 
    • January numbers indicated that inflation continues to accelerate (both the headline and core Consumer Price Index). At the same time, Treasury rates have begun to rise.
    • It’s important to remember that inflation decelerated rapidly beginning in April 2020, so that 2021 year-over-year comparisons may look artificially high due to base effects; but inflation pressures are certainly rising across many sectors of the economy and most acutely wages, housing and energy prices.
    • Long-term inflation expectations remain contained at around 3%.

  3. History says volatility will persist this year.
    • It’s not unusual for a flat/up year to include a sizable intra-year decline.

  4. "U" is for Ukraine. "U" is for uncertainty. 
    • A Russian invasion would be met by severe Western economic sanctions and would effectively create a separate economic bloc centered around China and Russia.

  5. Stocks are caught in a tug-of-war between earnings and interest rates. 
    • Key Private Bank still expects flat to slightly positive returns for calendar year 2022, but selectivity matters.
    • We continue to favor quality assets in general and are tilting client portfolios slightly towards cyclicality and value.

Equity Takeaways:

Stocks were mixed in early trading on Monday. After opening slightly higher, the S&P 500 was down about 0.5%, while small caps were flat. International shares, both emerging and developed markets, declined about 0.5%, extending weakness from last Friday’s session.

3-month VIX futures typically trade at a premium to spot VIX contracts. When spot VIX contracts trade at a premium to 3-month VIX futures, it tends to be a good buying signal.

The above dynamic in VIX futures occurred recently – the market quickly bounced but rolled back over, indicating continued choppiness over the near term.

Breadth continues to remain weak. Participation seems to be waning, and the market will likely have trouble putting in a tradeable bottom until breadth improves.

Investor sentiment remains markedly negative – most investors are scared and bearish over the short term. Typically, negative sentiment tends to be a contrarian buy signal. That said, price trumps sentiment. We will remain cautious on the near-term direction of the market until internals improve.

In several past episodes of Fed tightening (1994 and 2003-2004), US stock markets experienced intra-year choppiness, but ultimately recovered to move higher.

Fixed Income Takeaways:

Last week, the 2-year / 10-year Treasury curve continued to flatten and is now at its flattest level since mid-2020. The 2-year note yield rose 19 basis points last week, to 1.50%. The 10-year note yield rose only 3 basis points last week, to 1.94%. Yields rose again across the curve in early Monday trading.

Current market expectations are for five 25-basis-point Fed rate hikes by the end of 2022. Certain Fed officials feel that the Fed should be very aggressive with their initial trajectory of interest rate increases, but Chairman Powell’s opinion will carry the most weight.

To prevent an inversion of the yield curve, the Federal Reserve may attempt to engineer longer-term Treasury yields higher with "quantitative tightening" later this year.

Investment-grade (IG) corporate issuance was light last week. Many issuers are waiting for more favorable conditions before tapping the market. In general, investors are still looking for high-quality assets – demand remains strong even amidst slowing supply.

High-yield CDX (credit default swaps), a measure of the cost to insure against corporate default, continues to drift wider. Trading remains orderly.

The real Federal Funds rate (Fed Funds minus inflation) is the lowest on record. In the past, similar episodes have required significant rate increases to stem inflation, however, the pandemic has distorted supply chains and the labor market. This time may be different.

The lowest quality high-yield bonds, CCC-rated paper, have outperformed the rest of the high-yield market over the last few weeks. This type of price action is encouraging – bond market participants do not seem worried about increasing default rates.

General Takeaways:

  1. The economy is learning to live with COVID-19.

    • It’s becoming less and less likely that COVID-19 itself will become another major economic event. Omicron variant cases have peaked and are declining sharply across the United States.
    • Despite concerns of a virus-induced slowdown, last Friday’s employment report was extremely strong. The labor force surged by 1.4M workers, increasing the labor force participation rate by 0.5% to 62.2%.
    • Average hourly earnings soared 0.7% month/month and 5.7% year/year.

  2. Central banks around the world are getting aggressive to confront inflation.

    • Inflation will be the economic legacy of the COVID-19 pandemic.
    • An aggressive, hawkish Federal Reserve (the Fed) is a 180-degree pivot from 2009-2021 policy. The European Central Bank has also recently pivoted to a more hawkish stance.
    • Government bond yields are rising around the world, which is impacting mortgage and lending rates. The era of negative interest rates may be ending.
    • Chinese policymakers are cutting interest rates this year, in contrast with most other global central banks.

  3. Markets will remain on edge in the near term.

    • The impact of inflation on earnings, stock valuations and Fed policy remains unclear.
    • The 2-year / 10-year Treasury yield curve slope has declined recently, signaling that investors should be cautious. However, the slope of the curve is still positive, so this indicator is not an explicit red flag yet.
    • Credit spreads have drifted wider in an orderly fashion over the past few months.

  4. The economy continues to grow above trend.

    • Continued strong corporate earnings growth will be extremely important for stock market performance in the coming year.
    • Key Private Bank does not expect a recession in 2022. We continue to recommend a slight overweight position to stocks versus bonds in client portfolios.

Bottom Line:

  • Fundamentals again matter – we expect wide dispersion among winners and losers in 2022.
  • Selectivity, diversification and discipline will be keys to navigating this more challenging market environment. The current situation favors active management.
  • Despite increased volatility, future stock returns should remain supported by continued, strong economic growth.

Equity Takeaways:

Stocks opened slightly higher in early Monday trading. The S&P 500 rose about 0.2%, with small caps up about 0.5%. International shares were essentially flat.

Last week was the strongest of 2022, with the S&P 500 rising 1.5%. The weekly trading range tightened compared to prior weeks indicating less overall volatility.

Implied volatility (VIX) once again closed above 20 last week, opening Monday trading at approximately 23.3. The VIX has traded above 20 for four consecutive weeks, the longest such streak in about a year.

In a positive development, breadth was strong last week, with advancers significantly outnumbering decliners.

The market’s response to the fourth quarter 2021 earnings season has been muted. Companies that have beaten analysts’ estimates are being rewarded less than usual, while companies that have missed estimates are being penalized less than usual.

Overall, about 76% of reporting companies have exceeded analysts’ estimates for earnings, with the average beat at 8.2%. 77% of reporting companies have beaten revenue estimates. While not quite as strong as recent quarters, these numbers indicate that corporate profitability remains resilient.

During Fed tightening cycles, earnings multiples usually compress, and that is exactly what we have seen over the past few weeks – the market’s Price/Earnings multiple has been declining.

Strong earnings generally take a “fat tail” market event off the table. In other words, major (20%+) drops in the stock market usually don’t occur while earnings growth remains this strong.

We continue to recommend a slight “value” tilt in client portfolios. As noted above, selectivity remains very important.

Fixed Income Takeaways:

Bond market participants continue to closely watch incoming data for clues as to future Fed policy. Friday’s strong employment report also resulted in another significant rise in yields.

2-year Treasury note yields rose over 10 basis points (bps) last week and were trading at 1.30% Monday morning. 10-year note yields also rose sharply and were trading at 1.93% Monday morning.

Fed Funds futures are now pricing in at least five total rate hikes in 2022, with a substantial chance of an initial 50 basis point hike in March 2022.

Investment-grade (IG) credit spreads were stable last week, with the energy sector outperforming. The IG index now yields 2.93%, its highest yield in quite some time.

New corporate bond issuance remains heavy, but the overall pace is slightly below that of 2021. Financial companies have been especially busy issuers year-to-date.

Corporate bond spreads are widening, but trading remains orderly. IG spreads have drifted up to levels last seen in late 2020. The high-yield CDX index, a measure of the cost to insure against credit risk, broke into new interim highs last week.

Municipal bonds had a tough January 2022, with 5-year high-quality municipal bonds dropping 2.5% in value. Municipal bond mutual funds have seen several weeks of outflows this year.

Municipal bonds were expensive relative to treasuries throughout much of 2021. In the last month, municipals underperformed treasuries and are now more fairly valued.

General Takeaways:

  1. The Federal Reserve (Fed) is beginning the process of getting aggressive to confront inflation.

    • US Composite Purchasing Manager Index (PMI) data declined to 50.8 in January (an 18-month low).
    • That said, both the housing market and the labor market remain strong.
    • Nominal GDP is expected to have risen 14.3% in 2021 and the economy is poised to experience above-trend growth in 2022… Not to the same extent as 2021, but few economists are calling for a recession. Moreover, Omicron cases are falling rapidly implying that any “soft patch” experienced in late Q4/early Q1 should abate.
    • It is important to note that while the Fed has begun to tighten policy, its current policy stance is not restrictive (rates are still very low relative to history).

  2. The market narrative has changed.

    • The Fed will likely move faster than expected, and it may be less concerned with the stock market compared to 2013 (the last “Taper Tantrum”).

  3. Investors should brace themselves for increased volatility.

  4. Metrics to help determine if or when investors should become more defensive include:

    • credit spreads;
    • the shape of yield curves; and
    • earnings growth.

  5. Key Private Bank positioning recommendations:

    • Stay slightly “risk-on” and tilt toward cyclicals (value) and quality.
    • If the recent turbulence is causing you anxiety, you probably have too much exposure to risk – it’s never too late to recalibrate and rebalance.
    • Stay humble, stay disciplined, and don’t let your “present self” undermine your “future self” by reacting too much to daily volatility.

In the past week, the Fed released information on a Central Bank Digital Currency (CBDC). On the margin, a CBDC would de-emphasize commercial banks by allowing direct transactions via blockchain. The Fed is likely to move very slowly in the adoption of this technology – Congress would need to authorize this change via updated legislation.

Equity Takeaways:

The stock market rallied sharply last Friday to close slightly higher on the week. Volatility exploded to the upside last week, with four swings up and four swings down of at least 2.8% last week in the S&P 500. We expect this sort of choppy trading to continue for quite some time.

Through last Friday, the S&P 500 was down about 6.9% on the year. Value stocks have significantly outperformed growth stocks year-to-date (YTD). International shares have also outperformed YTD.

In early trading on Monday, stocks rallied slightly. The S&P 500 rose about 0.5%, while small caps rose about 0.3%. The tech-heavy Nasdaq rose over 1%. International shares were also higher.

Earnings estimates are continuing to grind higher, but to this point, the positive revisions have not been enough to offset fears about widening credit spreads and tightening Federal Reserve policy.

It is important to note that all risky assets have not traded in the same manner this year. Real assets (including energy stocks and industrial metals) have performed well. Also, floating-rate levered loans (a form of high-yield debt), have performed very well over the past few weeks.

Fixed Income Takeaways:

The 2-year / 10-year Treasury curve continues to flatten. This spread between the 2-year note yield and the 10-year note yield has dropped to about 60 basis points (bps), its tightest level since late 2020.

Credit spreads widened last week. Investment-grade (IG) corporate bond spreads widened 6 basis points (bps), while high-yield spreads widened 32 basis points. High-yield spreads are now 51 bps wider on the year.

Widening credit spreads amidst a flattening yield curve are both signs that market participants are worried about future economic growth.

Fed Chairman Jerome Powell’s press conference last week was interpreted as hawkish. Powell noted that the labor market is much tighter than it has been historically – implying a faster pace of future Fed Funds rate hikes than the market had anticipated.

Powell also noted that the Fed will need to be “nimble” and “humble,” implying that the Fed will be watching both economic data and market expectations closely over the next few months. The Fed also implied that they may begin reducing the size of its balance sheet faster than expected.

In short, Powell did not commit to a specific path for the future of monetary policy, stating that controlling inflation is the Fed’s #1 goal. Currently, market expectations are for five 25 basis point rate hikes in 2022, with about a 50/50 chance of a 50 bps hike to begin the cycle in March 2022.

During the history of Federal Reserve rate hiking cycles going back to 1990 (four separate cycles), the Fed has never started a rate hiking cycle with a 50 bps rate hike. Each cycle is unique and today’s environment has a significantly higher inflation challenge than previous cycles, which may open the door for accelerated hikes.

During each of these cycles (1994-1995, 1999-2000, 2004-2006 and 2016-2018), both stocks and bonds managed to deliver positive returns throughout the cycle.

General Takeaways:

Federal Reserve (Fed) Chairman Jay Powell will hold a press conference today (Wednesday, 1/26). Powell’s tone (hawkish or dovish) will be very important to global markets.

The Fed has put itself in a tough spot. Inflation is here. Tightening policy too much could hurt the stock market now; tightening too little could create an inflation problem later.

Further complicating the situation – some view inflation as a political problem. The Fed may feel compelled to “fix inflation” in response to these political pressures, irrespective of their effect on the stock market.

Will the Fed tighten policy if stocks are in a bear market?

- We don’t think so, but we don’t know for sure.

- Unless the odds of a recession rise materially, Key Private Bank maintains the view that hot inflation and crowded markets augur for flat index returns in 2022.

- Volatility should persist but sell-offs should be contained. 10-15% stock market drawdowns are not uncommon in any given calendar year.

- We continue to recommend that investors focus on quality assets. We recommend tilting portfolios slightly towards value / cyclicals.

Equity Takeaways:

Stocks bounced higher in early Wednesday trading. The S&P 500 rose over 1.5%, with small caps up a similar amount. The tech-heavy Nasdaq, which has borne the brunt of the recent selling, rose about 2.0%.

As of yesterday’s close, the S&P 500 had fallen about 8.5% year-to-date (YTD). Large cap value stocks have fallen about 3.9% YTD, while large cap growth stocks have fallen about 13.2% YTD.

International shares have provided important diversification over the past several weeks. Non-US developed markets have fallen 4.9% YTD, while emerging market equities have held up the best, declining just 0.4% YTD.

Our base case revolves around a continued valuation re-adjustment for very high beta / unprofitable stocks, which have fallen precipitously in the past few months. The Fed is likely not concerned with supporting these speculative names.

The bearish case for equities rests on the credit markets. If the credit markets were to weaken sharply due to a major Fed policy error, stocks could fall further.

If the recent selloff continues to spill over into the broader market (continuing to expand from more speculative names), the Fed will likely become more concerned as it could impact the broader economy.

Fixed Income Takeaways:

Despite the recent high volatility in the stock market, credit spreads have remained contained. If credit spreads were to widen, such price action could be a harbinger of a weakening economy and/or a Fed policy error.

The CDX index (aka credit default swap index) is a measure of the cost to insure against corporate defaults during the next 5 years. The index widened sharply during the 2020 crisis. Recently, CDX spreads have moved slightly higher, but the move has been unremarkable.

The front-end of the yield curve is very sensitive to Fed policy. Front-end treasury yields have risen sharply over the past several months. The 2-year Treasury note was yielding 1.04% in early Wednesday trading.

Meanwhile, longer-dated Treasury yields have fallen over the past several weeks (as stock market volatility has increased). Falling longer-dated yields tend to indicate that market participants are worried about long-term growth. The 10-year Treasury note was yielding 1.78% in early Wednesday trading.

Current Fed Funds rate market expectations (the current rate is a range of 0.0% to 0.25%):

- 4 total rate hikes in 2022 of 25 basis points (bps) each.

- 2-3 additional 25 bps rate hikes in 2023.

- Several more 25 bps hikes in the 2024-2026 period.

- Market expectations for the terminal Fed Funds rate are in the 2.0% to 2.5% range.

General Takeaways:

  1. Inflation is here.

    - Friday’s Employment Cost Index (ECI) report will highlight continued rising wages and the Omicron variant is making matters worse as it continues to distort supply chains as many workers are being forced to call in sick.

  2. The Federal Reserve (Fed) appears poised to officially begin tightening monetary policy.

    - Fed Chairman Jerome Powell will hold a very important press conference on Wednesday, January 26th to announce the Fed’s updated plans in response to rising inflation.

    - Tapering of asset purchases will likely conclude in March and the Fed’s balance sheet could start shrinking in the ensuing months; the net result is a draining of liquidity from the economy.

    - Fed Funds rate hikes will follow soon thereafter. Market participants believe that there is a 90%+ chance of at least one 25 basis point rate hike by the March 16th Fed meeting.

  3. Economic growth has begun to decelerate. Importantly, the economy is still expanding but at a slower pace.

    - Excess inventories are being worked out (demand for certain goods was pulled forward).

    - Over the near term, inflation and excess inventory may pressure earnings. Production may slow in certain sectors as inventory is drawn down.

  4. Geopolitical risks are rising.

    - The potential for armed conflict between Russia and Ukraine could cause stagflation in the Eurozone and United Kingdom.

    - Such a conflict would likely significantly raise the price of natural gas in Europe and the UK, squeezing real incomes and causing more hawkish behavior by the Bank of England.

    - A conflict would also negatively affect trade flows in Europe, putting the European Central Bank in a tough situation.

  5. Hot inflation and crowded markets augur for flat returns.

    - Volatility will persist, but selloffs should be relatively contained. 10-15% drawdowns in the stock market are not uncommon in any single calendar year.


Elsewhere, while interest rates in the US and other parts of the world are poised to rise, Chinese officials cut interest rates last week. 1-year and 5-year rates were both cut, helping smaller companies as well as mortgage borrowers. Mortgages in China are pegged to the 5-year rate.

Additional rate cuts are expected in China in mid-February as well as March.

Equity Takeaways:

Stocks fell in early Monday trading. The S&P 500 dropped over 2.5%, while small caps fell over 2%. The tech-heavy Nasdaq also fell over 2%.

Last week, the S&P 500 dropped just over 6%, its worst week in over a year. Through last Friday, the index has dropped about 7.7% year-to-date (YTD).

Dispersion amongst sectors remains high. Since last Friday, the S&P 500 Value Index was down about 3.1% YTD, while the S&P 500 Growth Index was down over 11% YTD. Small caps have also fallen over 11% YTD.

International shares have fared a bit better over the last few weeks. Developed market shares (ex-US) have dropped about 2.3% YTD. Emerging market shares have risen about 2% YTD.

The tone of the market has changed. The S&P 500 is trading below its 200-day moving average for the first time since the post-pandemic lows. Institutional selling is driving the market down, not a retail panic. Overall, the selloff has been orderly.

Some short-term indicators of sentiment show that investors are very nervous. A contrarian short-term bounce is always possible once investors become very bearish about the near-term outlook.

For example, implied volatility (VIX) spiked to over 37 in early Monday trading, its highest level in about a year.

The wide recent dispersion in the market should create an opportunity for active managers to outperform their benchmarks.

Fixed Income Takeaways:

Last week, investors began to rotate into high-quality longer duration assets. The 10-year yield touched as high as 1.90% on Tuesday, before dropping towards 1.72% in early Monday trading. As a result, the yield curve continues to flatten.

Market participants remain very worried about an increasingly hawkish Federal Reserve. Some even fear that the Fed could hike rates by 50 basis points (bps) during their March meeting.

Corporate credit spreads remain contained but drifted wider last week due to continued heavy supply. High-yield spreads also widened in an orderly fashion. Monitoring credit markets will be important amid equity market volatility. Key Private Bank continues to prefer high-quality corporate bonds versus treasuries in client portfolios.

Municipal bond fund flows have turned negative in 2022. Money has flowed out of the sector for two consecutive weeks. This is a change in market dynamic, as the sector saw very steady inflows throughout 2021.

After outperforming throughout 2021, municipal bonds have underperformed treasuries year-to-date. Front-end (2-5 year) municipal yields are up over 30 basis points YTD.

General Takeaways:

Equity Takeaways:

Fixed Income Takeaways:

General Takeaways:

On Thursday, January 13th, at 2:00 pm ET, Key Private Bank will be hosting another National Client Call. Our featured guest will again be Dr. Stephen Thomas, Chief of the Division of Infectious Diseases at SUNY Upstate Medical University.

Link to Register for January 13th National Client Call

The KeyBank Investment Center has also launched a new weekly podcast, which can be found here:

Key Wealth Matters | End of Week Market Minutes Recap - January 7, 2021

Key Takeaways for the Week:

  1. Monetary accommodation will end soon.

    - Last week, the Federal Reserve (Fed) released the minutes from its December meeting, which continued their recent pivot towards a more hawkish tone.

    - The Fed will soon stop expanding its balance sheet, and shortly after that, will likely begin increasing interest rates. Rate hikes could begin as soon as March 2022.

  2. Inflationary pressures may persist.

    - The labor market remains tight due to continued gains in employment. Wages continue to increase.

    - The unemployment rate has fallen to 3.9%.

    - The Core Consumer Price Index (CPI) is expected to rise about 5.5% year/year in early 2022, which would be the highest level seen in this metric since the late 1980s / early 1990s.

  3. Volatility increasing.

    - When the Fed begins to remove monetary accommodation, stocks and other risky assets tend to wobble.

    - Under the Fed’s yearly rotation cycle, the composition of the voting members in the Federal Reserve is changing. Some new voting members appear to be more hawkish than their outgoing counterparts.

  4. Corporate earnings should remain strong.

    - Evercore ISI survey data indicates that corporations have continued pricing power, which should help support corporate margins and profits.

  5. COVID-19 may soon be viewed as an endemic, not a pandemic.

    - Omicron cases appear to have peaked in South Africa and London without a large rise in hospitalizations.

  6. Bottom Line:

    - Rebalance portfolios as needed, but don’t overreact to volatility early in the year.

Equity Takeaways:

Stocks fell in early trading on Monday. The S&P 500 dropped about 1.7%, with small caps falling about 1.5%. International shares also fell.

Last week, the S&P 500 fell about 1.8%. Large value stocks rose 1.1%, while large growth stocks fell 4.5%. International shares (both developed and emerging) dropped by about 0.2%.

High-quality stocks outperformed low-quality stocks last week. Key Private Bank continues to maintain a quality bias in client portfolios.

Stock markets are taking their cue from interest rates. Rising interest rates are putting pressure on stocks, especially longer-duration growth stocks.

Since the start of 2018, the S&P 500 has logged consecutive 1% weekly declines on 11 occasions. Of those occasions, 8 of those 11 were in 2018 and 2020 (four in each year).

Conversely, the years prior (2017 and 2019) were characterized by strong uptrends and low volatility. To us, 2021 closely resembled 2019.

This pattern doesn’t guarantee a volatility explosion in 2022, but if the recent string of alternating low volatility to high volatility calendar years holds, 2022 may be a bumpier ride than 2021.

Gold tends to be inversely correlated with real rates (inflation-adjusted bond yields). As real rates rise, gold tends to underperform. Real rates have increased significantly over the past few weeks due to expectations for Fed rate hikes.

Cryptocurrencies have fallen about 50% over the last two months – cryptocurrencies often trade in “risk on” or “risk off” fashion in reaction to changing market sentiment.

Fixed Income Takeaways:

Monday morning, the 10-year Treasury note was trading at 1.81%. The 10-year note yield has broken through significant technical resistance at the 1.75% level. Also, 10-year yields have exceeded the recent peak reached in March 2021 and are rising to levels last seen before the pandemic.

Intermediate to long-end Treasury yields rose over 20 basis points last week. With shorter-duration Treasury yields rising less than longer-duration yields, the 2-year / 10-year Treasury curve has steepened to its widest level in over a month.

The new issuance of investment-grade (IG) corporate bonds was about $60 billion last week, significantly topping syndicate estimates. Spreads remained firm even as Treasury yields rose.

As noted above, the December Fed minutes, released last week, were viewed as hawkish. The Fed continues to worry about increasing inflation. The minutes also noted that existing emergency policy measures are no longer necessary due to continued economic and labor market strength.

Market participants are pricing in about an 80% chance of an initial Fed Funds rate hike in March 2022. The consensus is for three total rate hikes in 2022 (recall that the current rate is effectively 0%).

General Takeaways:

Many of the same themes that dominated the end of 2021 are likely to persist into early 2022:

  • Inflation
  • COVID-19
  • Federal Reserve (Fed) Policy Pivot

Our 2022 Outlook in a Nutshell:

  1. Hot Inflation
    • Not the 1970s, but not the 2010s either.
    • Is inflation peaking? Despite a recent drop in commodity prices, it’s too early to tell.
    • Housing prices, energy costs, and labor markets will need to be monitored closely.
  2. Crowded Markets
    • 5 stocks = 24% of the S&P 500 index.
    • BBB-rated bonds now comprise over 50% of the investment-grade bond index. As a result, today's bond market is riskier and more susceptible to swings in interest rates than in the past.
  3. Flattish Index Returns
    • We are not calling for a recession in 2022.
    • Economic growth should remain strong, but the Fed will begin draining liquidity from the system.
    • Active managers should have an opportunity to outperform the major indices in such an environment.

COVID-19 Update - Could Omicron be Peaking?

  • In South Africa, cases peaked roughly 30 days after the initial outbreak. To this point, fatalities related to Omicron have remained low in South Africa.
  • For comparison, New York City is about three weeks into its Omicron outbreak.
  • The Omicron variant has caused some moderation, but not a plunge, in US activity thus far.
  • Kids’ ability to return to the classroom after this year’s winter break could impact the economy via supply/labor participation rates.

2021 Returns:

  • Large cap US stocks led the way, with the S&P 500 up 28.9% during 2021.
  • Small cap US stocks rose 14.8%, while non-US developed equities rose 12.1%.
  • Emerging market (EM) equities were essentially flat, but EM saw lots of dispersion amongst individual countries.
  • Fixed income returns were mixed. High-yield bonds rose 3.8%, while municipal bonds rose about 1%. Investment-grade corporate bonds, as well as Treasuries, generally posted negative returns in 2021.
  • Real estate returns were also strong – publicly traded equity Real Estate Investment Trusts (REITs) were up over 41% in the calendar year, with most sectors bouncing back after a tough 2020.
  • Private core commercial real estate funds have risen 13.2% through 9/30/21 (as measured by the NCREIF ODCE index). Apartments and industrial properties continue to lead the commercial real estate market.

Equity Takeaways:

Stocks rose in early Monday trading. The S&P 500 rose about 0.3%, while small caps rose over 1%. International shares rose about 0.5%.

The early part of January tends to be a very seasonally strong part of the year – markets generally have a bias to the upside after a “Santa Claus rally.”

The market was up over 4% in December. Since 1928, the market has risen more than 4% in December 20 times (including 2021). The subsequent January saw positive returns more than 80% of the time, with an average move of 2.3%.

If January is weak this year, it will be a negative signal given the typical strong historical pattern and seasonal tailwinds.

The S&P 500 rose at least 10% in each of the past three calendar years (2019, 2020, and 2021). This pattern is very rare and has occurred only four prior times. The S&P 500 was up again the next year 3 out of 4 times. The only time the index lost ground in “year 4” was 2015, with a decline of only – 0.7%.

The S&P 500 has risen over 90% over the last three years combined. Typically, volatility increases after such substantial three-year gains, and index returns tend to be muted during the next several years. Thus, a period of consolidation may be necessary to digest the past several years of gains.

Fixed Income Takeaways:

Despite the recent spike in COVID-19 cases, fixed income market participants continue to expect the Federal Reserve to tighten monetary policy in 2022. As a result, the Treasury curve continues to flatten, with short-intermediate bond yields rising more than long-term yields.

The weakest portion of the Treasury curve in 2021 was the five-year note. Short-intermediate Treasury yields are very sensitive to Federal Reserve policy, while longer-duration Treasuries are more sensitive to economic growth expectations.

We expect a deceleration of investment-grade corporate bond issuance in 2022. In 2021, about $1.4 trillion of new supply hit the market. We still expect heavy issuance, but the pace should slow somewhat.

We expect a challenging 2022 for fixed income investors due to low current yields and a continued bias towards rising rates.

Any opinions, projections, or recommendations contained herein are subject to change without notice and are not intended as individual investment advice.

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