Investment Brief (Archive)

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.

Summary:

• 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.

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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.

General Takeaways:

Key Private Bank’s 2022 Outlook in a Nutshell:

1. HOT Inflation (not the 1970s, but not the 2010s either)

2. CROWDED markets

   - 5 stocks comprise 24% of the S&P 500 total market capitalization.

   - BBB-rated bonds comprise over 50% of the broad investment-grade index.

3. FLATTISH index returns (but not a recession)

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COVID-19 Update:

- Cases are beginning to re-accelerate, both within the United States and globally.

- Hospitalizations and fatalities have not yet begun to inflect higher. There remains hope that the Omicron variant will end up being more contagious, but less deadly than Delta – we need more data.

Inflation Update:

- An increased number of global COVID-19 lockdowns will likely occur.

- Labor and supply chain issues are far from normalizing, and any increase in lockdowns will only exacerbate any current shortages.

- Thus, increased lockdowns will likely be inflationary, rather than deflationary in the current environment.

US Politics Update:

- Voters’ concerns about inflation are rising. According to a recent poll from Politico, about 60% of Americans are “very concerned” about rising prices, and another 27% are “somewhat concerned.”

- Perhaps not coincidentally, President Joe Biden’s approval rating has dropped from about 55% in early 2021, to about 43% as/of mid-December. (FiveThirtyEight.com)

- The Biden administration’s Build Back Better legislation has effectively stalled in Congress. Senator Joe Manchin of West Virginia has withdrawn his support for the bill due to its projected cost.

Equity Takeaways:

Stocks fell in early Monday trading due to concerns about increasing global COVID-19 lockdowns. The S&P 500 fell about 1.4%, while small caps fell over 2%. International shares fell between 1-2%.

With the recent increase in volatility, we expect several busy trading days early this week before the holiday season kicks in. Market participants continue to look for more information surrounding the potential impact of the Omicron variant on global economic growth.

Interestingly, the National Football League (NFL) has implemented a policy whereby fully vaccinated, asymptomatic individuals will no longer be subject to weekly testing. Such an action could indicate that the NFL has seen declining severity among recent cases.

An initial rate hike from the Federal Reserve will not necessarily signal trouble for stocks. Historically, the stock market has been able to climb a wall of worry after the initiation of rate hiking cycles.

Fixed Income Takeaways:

US Treasury yields dipped lower in early Monday trading. The 10-year note yield fell three basis points, to 1.38%, while the 2-year note yield dropped two basis points, to 0.61%.

The treasury yield curve continued to flatten last week. The spread between the 2-year and 10-year treasury touched 74 basis points last week, the lowest spread since January 2021.

The flattening yield curve is being driven by two dynamics. Short-term treasury yields are rising due to expectations for Fed Funds rate increases in 2022. Long-term yields are dropping due to concerns about slowing economic growth.

The Federal Reserve (Fed) has consistently underestimated economic growth, as well as inflation, throughout 2021. As we’ve mentioned in recent commentary, the Fed has seemingly become much more concerned about inflation (hawkish).

The Federal Reserve is projecting a total of eight 25-basis point rate hikes by 2024, which would take the effective Fed Funds rate to about 2.0% by 2024. Market expectations are for a fewer number of rate hikes (4-5 total during this timeframe).

It’s also worth noting that several Fed governors are expected to be replaced in the coming months. Any change in Fed leadership (perhaps with more dovish members) could impact future policy.

General Takeaways:

KEY Takeaways for the Day:

1. COVID-19 Omicron Variant:

   - As of December 13th, according to federal data and the CDC, the Omicron variant has caused only mild cases in the US to this point. 80% of those infected in the US were vaccinated. From December 1-8, 43 cases of the Omicron variant were identified in the US across 25 states.

   - Hospitalization data from South Africa also indicates that the Omicron variant generally produces milder cases when compared to Delta, although Omicron does appear to spread faster.

   - Even before the identification of the Omicron variant in the US, cases have begun increasing in the US once again. As of December 8th, the 7-day moving average of new cases had risen 37% over the prior 7 days, to about 118,000.

2. Inflation Update:

   - US Consumer Price Index (CPI) data was released last Friday. The November All-Items data (CPI-U) rose 6.8% year/year, while Core CPI (ex-food & energy) rose 4.9% year/year.

   - The month-over-month percentage change in many of the underlying CPI component data moderated somewhat but generally remains elevated.

   - The price of Goods (ex-food & energy) rose 9.4% year/year, while Services (ex-Energy) rose 3.4% year/year.

   - We highlighted this unusual divergence between the price of Goods and Services in our 2022 National Client Call, held last Thursday, 12/9.

3. Federal Reserve Meeting to conclude on Wednesday 12/15:

   - This week, the Federal Reserve (Fed) will meet. On Wednesday, we expect the Fed to announce an accelerated timeline for asset purchase tapering.

   - Market expectations are for three Fed Funds Rate hikes by early 2023. Most analysts expect the Fed’s initial rate hike to occur in June 2022, with some predictions as early as March 2022.

4. Senate Advances Debt Limit Bill -

   Wrangling also continues in Congress over President Biden’s $2T Build Back Better bill.

The US economy is booming in nominal terms. US consumer net worth has risen 15% year/year. This data series is strongly correlated with real GDP and suggests continued strength in the economy will continue into 2022.

The unemployment rate continues to fall, and if current trends hold, we could see the overall unemployment rate drop towards 2.5% in 2022.

Based on the four most recent Federal Reserve tightening cycles, the stock market can continue to rise during rate-hike cycles. Often, negative market reactions occur with a delay or if the Fed tightens policy too much, causing an economic slowdown.

Equity Takeaways:

US stocks dipped in early trading on Monday. The S&P 500 fell about 0.4%, while small caps fell over 1%. International shares also fell.

Last week, the S&P 500 jumped 3.8% after declining two weeks in a row. Typically, after such a strong move higher, a period of modest upside or consolidation is the usual pattern.

Breadth in the S&P 500 was also very strong last week, with over 90% advancing stocks. 121 S&P 500 components were up more than 5%, while only four stocks in that index dropped more than 5%.

Implied volatility (VIX) declined over 39% last week, the third-largest weekly decline in volatility going back to 1990. Prior to last week, the VIX dropped at least 30%, and the S&P 500 rose 3.5% in the same week just four times. During the subsequent week, the S&P 500 was higher, and the VIX was lower 4/4 times.

Following this week, the last two weeks of the year are typically among the strongest seasonal periods of the year. The strong seasonal period will continue into early 2022.

Oil prices fell sharply several weeks ago after the announcement of the Omicron variant. Prices remain over 20% below the peak levels of early November. OPEC+ recently announced that they expect Omicron’s impact on global oil demand to be minimal.

US natural gas prices have also fallen sharply, about 50% below the October highs. Recent weakness has been caused by a mild early start to the winter and robust supplies.

Conversely, energy prices remain close to or above previous all-time highs in Europe and Asia.

Fixed Income Takeaways:

Yields across the Treasury curve rose last week, and the curve steepened as longer-dated yields rose more than front-end yields. That said, longer-dated Treasury yields remain stubbornly low even as inflation remains stubbornly high. On Friday, the 10-year Treasury note closed with a yield of 1.48%.

Corporate spreads stabilized last week, taking their cue from equities. High-yield bond spreads tightened 30 basis points last week, reversing much of their recent widening.

The recent influx of new issuance in the investment-grade (IG) bond market continues to be a technical headwind for corporate bond spreads. As we approach the end of the year, new issuance is expected to slow significantly.

Last week saw over $1 billion flow out of investment-grade bond funds, the second straight weekly outflow in the IG credit space.

General Takeaways:

COVID-19 Update:

- With the currently limited information available, we believe the Omicron variant is likely to delay, but not derail the ongoing economic recovery. Given that this variant is highly transmissible, vaccine efficacy will be significant.

- Travel restrictions have already been imposed and may accelerate due to “peak virus season.”

- More labor shortages and supply issues are highly likely and will be exacerbated by Omicron.

- Case growth has been flat in the US but seems likely to move higher. Global case growth is accelerating. That said, global fatalities have yet to inflect significantly higher.

Federal Reserve Hawkish Pivot:

- Last Tuesday, Federal Reserve (Fed) Chairman Jerome Powell made comments that shook up markets. The Fed is now emphasizing controlling inflation vs. stimulating maximum employment.

- Market participants now believe that the Fed is likely to raise the Fed Funds rate 50 to 75 basis points (bps) in 2022 (two or three rate hikes).

Economic Growth Remains Robust:

- In early 2020, about 22 million jobs were lost in just two months. 18 million of those jobs have now been recovered.

- The unemployment rate approached 15% during the COVID crisis. It has now dropped to 4.2%.

- Encouragingly, the labor force participation rate rose from 61.6% to 61.8% in November, indicating that discouraged workers are returning to the labor force.

- Total private wages grew 5.6% in November (year/year).

Summary: Hot, Crowded, and Flat

- Key Private Bank continues to favor stocks vs. bonds due to strong economic growth and low bond yields.

- Volatility will likely increase in an environment defined by hot inflation, crowded markets, and flattish returns.

- Since the March 2020 bottom, equity returns have been unusually strong and should be expected to moderate going forward.

- Investors should remain patient, avoid reacting to headlines, and stick to their long-term plan.

Equity Takeaways:

US equities were generally higher in early Monday trading. The S&P 500 rose 0.5%, while small caps rose over 1%. Technology shares lagged. International shares were mixed.

Due to a seasonal lull, analyst estimates for Q4:2021 earnings have been trending sideways to slightly lower over the past few weeks. As we’ve noted in the past, continued earnings growth will be necessary for stocks to move higher in 2022.

Natural gas prices fell 9-10% in early Monday trading. Positioning was very crowded on the long side, and some warmer than expected weather has dampened sentiment for natural gas. Oil prices rose slightly due to recent commentary from OPEC+.

Hedge funds had a difficult November, underperforming the broader market indices. In general, many hedge funds are levered to the “reopening” trade, which stumbled in November due to the Omicron variant news.

Also, many hedge funds are long growth stocks, which had a tough month due to anticipation of declining monetary stimulus. Growth stocks tend to be longer-duration cash flows with expensive valuations, and tightening credit conditions can have a negative impact on the sector.

Last Friday, bitcoin prices fell over 20%. Anticipation of decreased monetary stimulus (and lower ensuing liquidity) caused a steep selloff in many digital currencies.

Fixed Income Takeaways:

2-year Treasury yields rose 9 basis points last week to 0.60%, while the 10-year note yield dropped as low as 1.34%. The yield curve flattened significantly but remains relatively steep. Recall that a flat or inverted yield curve indicates that market participants expect slowing growth.

Shorter-term yields have risen in response to continued high inflation readings (and the recent Fed policy pivot in response to the inflation data). Long-term rates are dropping due to worries about slowing economic growth.

Due to a heavy supply of new issuance, credit spreads have begun rising over the past several weeks, but overall, spreads remain at relatively tight levels on a historical basis. We don’t believe the recent rise in spreads signals imminent economic weakness.

Credit spreads have become increasingly volatile, similar to the recent price action in equities. Last Tuesday, the day of Fed Chairman Powell’s comments, high-yield bond spreads widened by 30 basis points. High-yield spreads recovered later in the week to close 4 bps tighter on the week.

Another takeaway from Chairman Powell’s comments: The Fed is likely to end asset purchase tapering earlier than expected, and Fed Funds rate hikes will likely begin soon after that (likely mid-2022). The Fed has removed all references to “transitory” inflation.

Bottom line: The Federal Reserve remains accommodative with respect to monetary stimulus. However, the pace of stimulus is clearly slowing. This dynamic will have important implications for markets across the globe as we head into 2022.

General Takeaways:

COVID-19 Omicron Variant Thoughts:

- It will likely be 2-6 weeks before we know the global severity of this variant in terms of hospitalizations and fatalities.

- In early data, the transmissibility of Omicron seems to be higher than previous variants. However, the initial severity seems lower.

- As of Friday morning, cases of Omicron have been confirmed in five US states (for a total of 10 cases), highlighting how early we are in the Omicron outbreak.

- President Biden released details of his plan to combat the virus over the winter. Importantly, these plans do not contemplate further lockdowns or expand the existing federal vaccine mandates.

- With many conflicting opinions circulating, investors should not overreact to the steady stream of headlines that we are likely to see in the coming weeks.

Federal Reserve Update:

- On Tuesday, 11/30, during testimony to the Senate Banking Committee, Federal Reserve (Fed) Chairman Powell made comments suggesting that the Fed is becoming more worried about inflation. [details in fixed income section below]

- For context, at its November 3rd FOMC meeting, the Fed officially announced the tapering of their ongoing purchases of Treasuries and mortgage-backed securities at a pace that would conclude in June 2022.

- Powell’s comments this past Tuesday suggested that the Fed may increase their pace of tapering (finishing the process sooner, in March 2022). An accelerated timeline for tapering would open the door for Fed Funds rate hikes earlier than expected in 2022.

- The stock market reacted negatively to Powell’s comments.

KEY Takeaway:

Key Private Bank maintains an overweight position on equities vs. bonds despite increased volatility. We generally favor quality equities throughout a full cycle. Tactically, we have a slight bias towards cyclicals vs. defensives.

We also recommend allocating alternatives and real assets for additional diversification in a low-yielding environment.

Equity Takeaways:

Stocks were lower in early Friday trading. The S&P 500 dropped about 0.4%, while small caps fell about 0.7%. The Nasdaq fell over 1%. International shares were mixed.

The underlying breadth and volume of the market continues to indicate strength underneath the surface despite the recent volatility. For example, small cap industrials and semiconductors have both been performing relatively well recently – these are not market sectors that typically perform well during an extended selloff.

In short, early indications are that the Omicron variant will likely not derail the continued bull market. Our outlook will continue to evolve as new data becomes available.

In Japan, corporate balance sheets continue to improve, and the federal government continues to provide stimulus. The Japanese reopening story has yet to be told, so we think Japanese equities could outperform other developed international markets in 2022.

Fixed Income Takeaways:

Many market participants felt that Fed Chairman Powell would continue a dovish tone during this week’s press conference. Instead, Powell made a hawkish pivot and suggested that the word “transitory” should be removed from the Fed’s references to inflation.

Importantly, Powell noted that the Omicron variant’s potential effect on the economy is not currently factored into the Fed’s current outlook. Based on this comment, if the economy were to weaken sharply due to the Omicron variant, the Fed’s outlook could be updated again.

The bond market reacted sharply to Powell’s remarks. 2-year Treasury yields rose quickly and stood at 0.64% Friday morning. The 2-year yield is the tenor most sensitive to Fed Funds rate expectations.

10-year Treasury yields dropped after Powell’s comments, perhaps anticipating slowing economic growth. The 10-year yield was 1.46% Friday morning. Overall, the Treasury curve flattened this week.

Due to the Omicron news, market participants had ratcheted back their expectations for rate hikes before Powell’s comments. After Powell’s comments, the consensus is again for two rate hikes in 2022.

Corporate bond funds (both investment-grade and high-yield) saw sharp outflows last week, likely in reaction to increased volatility and widening spreads. These outflows were the first in four months.

Conversely, municipal bonds continue to see inflows. 80 of the last 81 weeks have seen positive flows into municipal bond funds. The asset class remains historically expensive relative to taxable bonds in the 2-5 year area of the curve.

General Takeaways:

COVID-19 Omicron Variant Update:

- We don’t believe the Omicron variant will derail the full economic recovery, but it will likely delay the process. This variant has quickly out-competed other forms of the virus in South Africa, and much is still unknown about its ultimate impact on hospitalizations and fatalities.

- Travel restrictions have already been imposed and may accelerate. Labor shortages and supply chain issues will likely continue, which will likely cause more distortion of inflation data.

- Human ingenuity is not standing still. Before the Omicron news, the US economy was displaying considerable momentum. Corporate profits are booming, and household balance sheets are generally in very solid shape.

- Last Friday’s market selloff was likely exacerbated by thin liquidity and algorithmic trading.

- Key Private Bank continues to maintain an overweight position towards equities vs. bonds. Within equities, we maintain a slight bias towards cyclicality versus defensiveness.

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Several weeks prior to Thanksgiving, COVID-19 cases were rising (especially in the Upper Midwest, Southwest, and parts of the Northeast). Vaccinations in the US also continue to increase slowly.

Even before the Omicron news, Continental Europe was the epicenter for the recent COVID-19 breakout. For example, a recent spike in the Netherlands has surpassed all previous outbreaks in terms of rolling 7-day case count. Over 72% of the population in the Netherlands is fully vaccinated.

A possible silver lining: over time, if this new variant spreads faster but is less virulent than previous strains, the impact on society could be positive. Some doctors in South Africa are commenting that they are seeing milder overall symptoms from Omicron than earlier variants.

Much is yet unknown. Investors should not overreact to incomplete information.

Equity Takeaways:

Last Friday saw a sharp stock market selloff during a holiday-shortened session. The S&P 500 dropped about 2.3%, with small caps falling 3.7%. European shares fell 3-5%, while shares in Asia were flat to slightly higher.

During Friday’s selloff, growth stocks outperformed value stocks. Defensive sectors, such as consumer staples, outperformed cyclicals.

Global stock markets bounced back slightly on Monday morning. The S&P 500 rose about 1% in early trading, while small caps rose about 0.50%. International markets were marginally higher as well.

Market participants are trying to digest the ultimate severity of the Omicron variant. If Omicron turns out to be more contagious but less severe than previous variants, global stock markets could react positively (and vice versa).

During the mid-May to mid-July 2021 “Delta Wave,” banks, energy, and materials shares were the weakest sectors, while sectors such as health care and technology outperformed. If anything, we suspect the current situation may be a bit worse than what we saw in May, at least over the short term.

Fixed Income Takeaways:

Just before Thanksgiving, the 10-year Treasury note was yielding close to 1.70%. On Friday, the 10-yr yield dropped to 1.47% as investors rushed into safe-haven assets. The 2-year and 5-year note yields dropped sharply as well.

Monday morning, yields have reversed somewhat higher but have not returned to pre-Thanksgiving levels. The 10-year note yielded 1.55% in early Monday trading, up about 8 basis points on the session.

Heavy new issuance of corporate bonds drove spreads wider before Thanksgiving, as $56 billion of weekly investment-grade issuance was too much for the market to absorb. Spreads widened another 7 basis points on Friday in reaction to the Omicron news.

The emergence of the Omicron variant could cause the US Federal Reserve (Fed) to remain “on hold” for longer than expected, possibly delaying rate hikes. That said, Fed Funds futures have not shown much reaction to the recent news and continue to price in rate hikes beginning in mid-2022.

General Takeaways:

Equity Takeaways:

Fixed Income Takeaways:

General Takeaways:

Markets continue to climb a wall of worry related to worsening COVID-19 case counts and rising near-term inflation.

The Conference Board Leading Economic Index (LEI) increased by 0.9% in October, bouncing back from a smaller 0.1% increase in September (growth scare). The LEI increased 0.7% in August.

Strong economic growth is evident in many areas of the economy. Retail sales rose 1.7% month/month and 16.3% year/year. Continued employment growth should support a strong holiday retail season.

Regional manufacturing indices showed solid growth in November. Both the Empire State and Philadelphia regions posted robust gains across virtually all underlying components.

Housing starts were down slightly in October, but building permits rose. Overall, the housing market remains a bulwark for the economy.

The Dallas Federal Reserve calculates a metric known as US Trimmed Mean Personal Consumption Expenditures (PCE) Inflation. This measure removes the most extreme price outliers to calculate core inflation. In 2021, Trimmed Mean PCE Inflation has risen to just over 3%, similar to levels last seen prior to the Great Financial Crisis of 2008-09.

Gold prices have risen recently, perhaps in response to inflation fears. Gold prices are still down slightly year-to-date (YTD), but recently reached a 5-month high.

COVID-19 update: the 7-day moving average of US cases increased 16% over the past week, to about 88,000. Hospitalizations increased slightly.

Vaccinations also continue to increase marginally. About 69% of the US population over the age of 12 is vaccinated, up from about 60% in August. As/of Friday morning, the FDA approved everyone over the age of 18 to receive a COVID-19 booster shot.

Emerging market (EM) countries are experiencing higher inflation than developed nations and have begun to raise interest rates as a result. Emerging market economies are generally more sensitive to rising food and energy prices (larger percentage of EM consumption baskets).

Equity Takeaways:

Proposed COVID-19 lockdowns in Germany and Austria are impacting market sentiment this morning. Austria’s lockdown is geared towards the unvaccinated population. Germany is considering locking down their entire country but will likely start with areas that show lower vaccination rates.

Equities were mixed in early Friday trading. The S&P 500 was essentially flat, while small caps dropped about 0.6%. International markets were also mixed, while the tech-heavy Nasdaq rose about 0.4%.

The Nasdaq has outperformed the broader market over the past week. As longer-dated treasury yields fall, technology shares tend to outperform – technology shares are longer duration assets.

The S&P 500 continues to consolidate post earnings, supported by continued improvement in 2021 earnings estimates. We continue to expect that a favorable earnings backdrop should support US equities as we head into year-end. COVID-19 remains a wild card.

Oil prices have become a proxy for short-term aggregate demand. In addition, talk of a possible release of strategic oil reserves in China and the USA has impacted oil prices, which are 15-20% off the recent highs.

Fixed Income Takeaways:

US treasury yields dropped in early Friday trading. The 10-year treasury yield, which touched 1.60% earlier this week, dropped to 1.53% on Friday.

The recent drop in longer-dated yields has caused the treasury curve to flatten. Conversely, shorter-duration treasuries are very sensitive to Federal Reserve (Fed) rate policy and have recently risen in yield (although yields were falling across the curve on Friday).

Investment-grade (IG) corporate bond spreads widened this week. $56B of new supply came to the market from 39 borrowers, and the market had trouble digesting this supply, causing spreads to widen 7 basis points on Thursday.

High-yield corporate bond spreads also widened this week amid heavy supply. CCC-rated bond yields touched a 10-month high. Despite the widening in spreads, corporate bond mutual funds continued to see heavy inflows.

Municipal bond markets were also very busy this week amid heavy new supply. Spreads were generally stable. The calendar is expected to be very light next week due to the Thanksgiving holiday. Positive mutual fund flows continue, and municipals remain expensive to taxable bonds on a relative basis.

General Takeaways:

1. Labor and inflationary pressures are both real.

   - According to Gallup, a record percentage of workers believe that now is a good time to find a job. This survey data is supported by the US Bureau of Labor Total Quits metric, which has also spiked. About 2/3 of the increase in quits has come from two sectors: leisure/hospitality and health services.

   - Despite the increase in quits, over the last few months, total private job openings have declined slightly (but remain at elevated levels). Employers are either curtailing hiring plans or shifting towards other sources of employment (automation, etc.).

2. Earnings growth must stay robust to support continued stock market performance.

   - At the end of September, Wall Street analysts were expecting third-quarter 2021 earnings of $48.89 per share for the S&P 500. The actual Q3:2021 result was 9.6% better at $53.60 per share.

   - Since the end of September, the index has risen 8.7%, mirroring the rise in reported vs. expected earnings.

   - See the “Equity Takeaways” section for details.

3. Politics are back to dominating headlines.

   - Federal Reserve Chair: Jerome Powell remains the favorite to receive another nomination from President Biden, and the news will likely be announced before Thanksgiving. Lael Brainard is considered a more progressive candidate than Powell – if she is nominated, increased short-term market volatility would probably result.

   - Debt Ceiling: December 10th is the next “deadline” for the debt ceiling increase.

4. COVID-19 Update.

   - New cases are climbing in certain areas of the country, including the Upper Midwest, Southwest, and parts of the Northeast.

   - The 7-day average of new cases has plateaued and ticked up slightly over the past several weeks.

5. COVID-19 Scientific Progress – Much to be thankful for.

   - Around one year ago, Pfizer announced the initial positive results of their COVID-19 vaccine testing, presenting results that showed over 90% efficacy.

   - On November 5th, 2021, Pfizer noted that its COVID-19 pill (when combined with an HIV drug) cuts the risk of hospitalization or death from COVID-19 by 89%.

6. Private core real estate returns have been strong.

   - Private core real estate returns were very strong in the third quarter of 2021, driven by the apartment and industrial sub-sectors. The NFI-ODCE index was up 6.6% in the third quarter of 2021 and was up 14.6% over the trailing 1-year period ending 9/30/21. Key Private Bank maintains a favorable view of this asset class as part of a diversified real asset strategy.

   - Higher construction costs and labor shortages are working to constrain commercial real estate supply – this is another factor supporting prices in the sector. Supply constraints and rising rents are two ways that core commercial real estate can act as an inflation hedge.

Equity Takeaways:

Stocks rose slightly in early Monday trading. The S&P rose 0.2%, with small caps also fractionally higher. International shares were essentially flat.

Last week, the S&P 500 fell marginally (0.3%), breaking a streak of four consecutive 1%+ weekly gains. The recent pattern corresponds closely with the year 2019. In 2019, the fourth quarter low occurred on October 3rd, and the S&P 500 advanced 11 out of 12 weeks to conclude the year.

Breadth has also been positive throughout the recent market strength. Last week, S&P 500 breadth was +53% but had been at least +70% for each of the four weeks prior. In short, we have seen broad participation throughout the recent rally.

With 92% of S&P companies reporting, the third quarter of 2021 has proven to be another strong earnings season. 81% of companies beat analysts’ estimates, with 75% topping revenue estimates. The 5-year historical averages for these metrics are 76% and 67%, respectively.

Forward earnings estimates could be too low. Street analysts are projecting a sequential decline in 4th quarter 2021 corporate profits, driven by a decrease in margins. Over the past few quarters, the pattern has been for analysts to increase their estimates during earnings season.

Estimates have dropped the most for the information technology, consumer discretionary, and communication services sectors. By contrast, cyclical sectors have experienced positive revisions in earnings estimates over the past several months. We continue to believe that cyclical sectors could lead the market higher into the end of 2021.

Fixed Income Takeaways:

Treasury yields rose slightly in early trading on Monday. The 10-year note yield rose four basis points (bps) to 1.60%, while the five-year note yield rose 3 bps to 1.26%.

Last week, the 10-year Treasury note yield rose about 11 bps to 1.56%. The 2-year / 10-year Treasury curve was essentially flat on the week at about 105 basis points.

Investment-grade credit spreads widened slightly last week to 88 bps. High-yield spreads widened about 8 basis points. With a corresponding rise in Treasury yields, high-yield bond yields saw their largest weekly jump in about six months. Overall, the high-yield bond index closed with a yield of about 4.23%.

Primary corporate issuance remains strong, with wide participation by issuers across various sectors. Corporate credit issuance continues to be met with solid demand.

Money-market yields have also begun to drift (slightly) higher, which has reduced demand for the Federal Reserve’s overnight lending facilities. The Fed generally pays 0.05% on overnight paper, and market yields have risen above that level recently.

General Takeaways:

Stunning improvement in the labor market continues, resulting in continued wage gains. According to the National Federation of Independent Businesses (NFIB), small businesses continue to raise wages to attract talent. The number of job openings also continues to increase, implying continued near-term bargaining power for workers.

Consumer Price Index (CPI) inflation data for October was released this week and showed a sharp increase. The sharpest month/month gains were concentrated in energy prices, as well as car and food prices. Shelter prices also rose – this number comprises 1/3 of the total CPI, so any incremental moves in shelter prices will significantly impact total CPI.

Market participants are now expecting several Fed Funds rate hikes in 2022. Based on previous guidance from the Federal Reserve (Fed), any rate hikes are not likely to occur until asset purchase tapering is complete. The Fed continues to expect inflation to moderate sometime in mid-late 2022. However, the recent CPI data is causing some market participants to challenge this view.

The steady recent decline in US COVID-19 cases has leveled off, with the 7-day moving average of new cases hovering about 75,000 over the past several weeks.

The Bank of England (BOE) decided against raising rates during their meeting last week in an unexpected move. The UK yield curve steepened as a result, and inflation concerns seem to be taking a backseat to labor market concerns.

Japan’s new Prime Minister, Fumio Kishida, is calling for a large fiscal stimulus plan, arguing that recent increases in inflation are supply related. Japanese corporate profits continue to surge. However, the Japanese stock market has not followed profits higher.

Producer prices in China tend to be volatile, but consumer prices often don’t increase in tandem. Recently, China’s CPI rose 1.5% year/year due to increases in food and fuel prices. “Singles’ Day” was November 11th in China – their version of Black Friday – and the first read is that sales were very strong.

Equity Takeaways:

US stocks rose slightly in early Friday trading. The S&P 500 rose about 0.25%, with small caps also slightly higher. International shares generally rose 0.3% to 0.4%.

Over the past five sessions before Friday, the S&P 500 experienced several choppy trading sessions, ultimately declining about 0.6% over that period. Small caps fared a bit better, rising 1.6% over the five sessions prior to Friday.

Perhaps in response to rising inflation expectations and the recent official passage of the US infrastructure bill (Infrastructure Investment and Jobs Act), cyclical sectors such as materials and industrials were the best performers over the past week.

Fixed Income Takeaways:

Wednesday’s CPI print had a significant impact on Fed Funds futures. Market participants are now expecting an initial rate hike in July 2022, from September 2022 prior.

The treasury yield curve continues to flatten, with short to intermediate yields rising sharply after Wednesday’s CPI data. This week saw the biggest weekly selloff in treasuries since February.

Corporate borrowers continue to flood the primary markets with new issuance, and despite the recent rise in treasury yields, overall borrowing costs remain low.

Investment-grade (IG) bond funds continue to show inflows. More than $2 billion of new money flowed into IG funds last week. In addition, high-yield funds saw the largest inflows since April, and leveraged loan funds also showed significant inflows. Spreads remain stable across corporate credit.

The curve flattened in the municipal market this week. The move was a “bull flattener,” where long-end municipal bond yields dropped while front-end municipal yields remained stable.

Another $1.1 billion of new money flowed into municipal bonds last week. Technical trading conditions remain strong. Inside 1-year, municipal yields are cheap to treasuries. Outside 1-year, municipals remain expensive.

General Takeaways:

Capital Markets Update:

Global capital market returns have been very strong in 2021. Global equities rose almost 5% in October and are now up about 15.4% year-to-date (YTD). Global bonds have dropped between 1-2% YTD.

Within the US, large caps rose 6.9% in October, led by large growth stocks, which rebounded sharply in October after lagging in September. Small caps rose over 4% in October. YTD, US large caps have risen 23.2%, while small caps have risen 17.2%.

International stocks continue to lag. Non-US developed market equities rose 2.4% in October and are now up 8.8% YTD. Emerging market equities continue to be affected by weakness in China – they rose 1.1% in October and are up 3.1% YTD.

Four Big Macro Themes:

1. COVID-19 appears to be waning.

   - Caution is likely still warranted as we move into the winter flu season.

   - Almost 10% of the fully vaccinated US population has received a booster shot.

2. Inflation is here (and seemingly more persistent).

   - Given the recent parabolic moves higher in recent inflation data, we should anticipate some reversal of the data in the coming months.

   - Nevertheless, inflation is likely to run above trend over the short/intermediate term.

   - Shipping/port pressures may be easing as the COVID-19 Delta outbreak wanes.

3. Higher interest rates may follow rising inflation.

   - In various parts of the world (Norway, Australia, Canada, UK), higher interest rates are likely coming. For example, the Norwegian central bank has already begun to hike rates.

   - Within the US, market participants expect at least one Fed Funds rate increase by mid-late 2022.

4. Pricing power remains strong and is supporting profits.

   - Revenues have been strong, but earnings have been even stronger.

   - 2022 estimates will be critical. Street analysts have not yet begun raising their estimates for 2022 (some skepticism remains).

What’s Key Private Bank’s outlook, and what should we be doing with portfolios?

- Discipline will be required going forward, as increased stock market volatility is likely.

- Remain overweight quality equities, real assets, and alternatives. Remain underweight fixed income.

- Economic growth should stay above trend in 2022, and we expect strong corporate profit growth through at least 1H:2022.

- Biggest macro threat to the long-term outlook is higher-than-expected inflation that persists, forcing the Federal Reserve into a position where they are required to raise interest rates earlier than anticipated. The slope of the yield curve remains an important indicator for this reason.

- On their own, rising rates are probably not enough to derail the continued bull market in stocks. According to RBC, since 1989, equities have performed relatively well during periods of slowly rising interest rates.

- Our full market outlook will be released in the coming months.

Equity Takeaways:

US stocks were mixed to slightly higher in early Monday trading, with the S&P 500 approaching another all-time high. The S&P 500 was essentially flat, while small caps rose about 1%. International stocks generally rose 0.5% - 1%.

As noted above, the S&P 500 is up about 23% to date and was up almost 7% in October (following a 4-5% decline in September). Investors clearly bought on the dip.

The strongest sectors YTD are energy, financials, and real estate. Defensives, such as consumer staples and utilities, have lagged the broader market YTD.

After the strong performance of growth stocks in October, the Russell 1000 Growth index is now up about 24% YTD, and the Russell 1000 Value index is up about 22% YTD. In essence, both Growth and Value have performed about equally well in 2021.

During 3Q:2021, about 82% of companies have beaten analyst estimates, vs. the long-term average of about 76% for this metric. See last Friday’s comment for a more detailed breakdown of 3Q earnings.

Fixed Income Takeaways:

Due to a rise in short-term Treasury rates over the past several weeks, the 2-year / 10-year Treasury curve has flattened – the curve contracted about 12 basis points (bps) last week to close at 107 bps last Friday.

On an absolute basis, the curve remains relatively steep, but this situation bears watching. A flattening yield curve can be a harbinger of slowing economic growth.

Overall, investment-grade (IG) corporate bond spreads have remained stable even as front-end Treasury yields have risen. IG spreads were flat last week, supported by continued strong investor demand for new issuance.

On Wednesday morning (11/3), the Federal Reserve (Fed) will release its November 2021 statement. Fed Chairman Jerome Powell will also hold a press conference. It is highly likely that the Fed will announce a tapering of asset purchases at this meeting.

Market participants will be watching the Fed’s statement very closely for any changes to their long-term inflation outlook. Powell’s press conference will also be scrutinized.

General Takeaways:

GDP for Third Quarter 2021 (advance estimate) slowed more than expected, dropping to 2.0% vs. expectations of 2.7%. In the second quarter, real GDP increased 6.7%. Recall that the four “growth scares” since the 2009 trough have been good buying opportunities in the stock market.

Regional Federal Reserve Manufacturing District economic data continues to paint a similar picture – economic output slowed slightly recently but is still growing at a solid pace. Durable goods orders softened slightly, while the housing market remained a bright spot.

Initial unemployment claims dropped once again, another signal of a tightening labor market. That said, US Nominal GDP divided by US Payroll Employment reached an all-time level last month, indicating that Productivity is still high.

Employment Cost Index (ECI) data was released Friday morning. The key number in this data series, “wages and salaries for private industry workers,” showed an increase of 4.6% in September. For context, at the beginning of 2016, this number was 2.0%, and just before the pandemic, it was 3.0%.

Consumer sentiment (as measured by both the Conference Board and Bloomberg) has dipped recently, impacted by rising gasoline prices, but remains well off the pandemic lows of mid-2020.

COVID-19 Update: The 7-day moving average of cases is below 70,000, back to levels last seen in late July. Hospitalizations are also declining. According to the CDC, for all adults age 18 and over, unvaccinated patients are about 12 times more likely to be hospitalized with COVID-19 than vaccinated patients (data from 1/30/21 to 8/28/21).

The Chinese government is attempting to support small and medium-sized businesses by providing tax relief (essentially targeted stimulus). The government also instituted price targets on coal, which caused a 42% drop in Chinese domestic thermal coal prices.

The Chinese government also ordered Evergrande’s Chairman to make good on offshore bond obligations. Evergrande paid their obligations on the last day of the 30-day grace period. This situation does not appear to have caused any major contagion.

Equity Takeaways:

US stocks dipped slightly in early trading on Friday. The S&P 500 dropped 0.25%, while the Nasdaq dropped about 0.5%. Small caps were also down slightly. International shares (both developed and emerging markets) each fell about 1%.

Two very large technology companies reported unimpressive earnings Thursday night, which is weighing on the overall stock market this morning. Supply chain issues and labor shortages are affecting companies across industries.

The recent strong performance of equities has improved S&P breadth, with 53% of constituents above their 50-day moving averages. About 44% of Nasdaq constituents are above their 50-day moving averages (had been mid-20% range over the summer).

A bit over half of S&P 500 constituents have reported 3Q:2021 earnings. About 82% of S&P 500 companies have beaten consensus estimates for earnings in Third Quarter, down from about 86% in 2Q:2021.

That said, fewer companies have beaten revenue expectations. Only 66% of companies have beaten revenue expectations in the third quarter, down from 83% in the second quarter of 2021.

One main theme of the third-quarter earnings season – inflationary / supply chain pressures are likely to remain an issue well into 2022. Many investors are concerned about 2022 profitability as a result.

As we’ve noted in past comments, companies that have missed earnings estimates in the third quarter are paying a high penalty in terms of their stock price (more than companies are being rewarded for strong earnings).

Fixed Income Takeaways:

The 5-year portion of the Treasury curve has become the most sensitive portion of the curve to Fed Funds rate expectations. The 5-year yield has risen sharply in the last several months. At the beginning of September, the 5-year Treasury note yielded 0.77%. Early on Friday, the 5-year note was trading at 1.22%.

Recent Treasury auctions (2-year, 5-year, and 7-year) were all met with strong demand despite the rise in yields. Foreign buyers likely comprise a good portion of this demand due to very low yields overseas.

2021 has been a “tale of two halves” for bonds. The first quarter of 2021 saw a bond selloff, most of which was retraced by a strong rally in the second quarter. Recently, intermediate-term Treasury yields have continued to rise, while yields on 30-year Treasuries have stabilized and even dropped slightly.

CCC-rated paper has widened significantly since the tightest levels from July. That said, overall credit spreads are lower now than before the Great Financial Crisis, implying that financial conditions remain very easy.

The ongoing legislative battle in Washington could significantly impact the municipal bond market (depending on the exact legislation passed). Two possible changes: a renewal of tax-free advance refunding issues or a reinstatement of a direct subsidy bond program (similar to Build America Bonds). At this point, neither feature seems likely to be included in a final budget plan, but we will continue watching for updates.

Inside 1-year, municipal bonds are cheap to Treasuries. Outside 1-year, municipals remain expensive, with spreads supported by continued inflows. That said, the pace of inflows has slowed recently, and municipals have begun to cheapen slightly over the past few weeks.

General Takeaways:

Three key data points to watch this week:

1. We’ll find out how much the economy slowed in the third quarter of 2021.

   - Real GDP data will be released on Thursday. Personal Income and Consumer Spending data are due on Friday.

   - The Atlanta GDPNow forecast for Third Quarter 2021 slowed significantly over the past few months, as has the Blue Chip consensus. As we’ve noted in the past, this “growth scare” could be one reason the stock market showed weakness in September.

   - In October, several important indicators, such as bank loans and US Composite Purchasing Manager Index (PMI) data, showed continued expansion. Others, such as industrial production, were a bit softer.

2. Inflation updates – currently still the most significant risk to the macroeconomy in our view.

   - Employment Cost Index (ECI) data will be released on Friday.

   - PMI Output Price survey data for both the services and manufacturing sectors continued to indicate sharply rising prices in October.

   - In response to rising inflation expectations, futures market participants are now expecting a faster pace of interest rate increases than they were one month ago: today, future markets assign a probability of only 38% that interest rates will remain unchanged by mid-2022. One month ago, that probability was near 84%.

3. Corporate profitability – earnings reports will give us more information on whether companies are withstanding increases in labor costs and supply shocks.

   - 3Q:2021 earnings season has been solid to this point, with 82% of companies topping projections, led by financials. 316 companies representing 59% of the S&P 500’s market capitalization will report over the next two weeks.

COVID-19 Update: Global case curves seem to have flattened dramatically in places like the United States, India, Japan, Canada, and Israel. The UK and China are two significant exceptions, and both continue to deal with flare-ups of the virus.

According to PredictIt.org, the chances for an increase in the US corporate tax rate above its current level of 21% dropped significantly over the past week, likely due to continuing gridlock in Washington DC.

Various cryptocurrencies have surged in price since bottoming in July. Several new exchange-traded funds (ETFs) were recently launched last week - these funds hold futures contracts. Bitcoin futures ETFs will generally have high carrying costs (roll costs) due to the typical upwards-shaping slope of the bitcoin futures curve.

Equity Takeaways:

US stocks were essentially flat in early Monday trading. The S&P 500 rose 0.1%, while small caps rose 0.2%. The Nasdaq fell 0.1%. International stocks fell slightly.

Last Friday, the S&P 500 concluded a 7-day winning streak by closing marginally lower. However, it did set a small intraday all-time high. This streak was the second 7-day winning streak in 2021.

Last week, the S&P 500 logged its second straight weekly gain of at least 1.5% for the 12th time since the start of 2019. Typically, the stock market has a slightly positive weekly bias after such a pattern.

Breadth in the S&P 500 expanded to +78% last week, which was enough to push the cumulative S&P 500 advance/decline line to an all-time high. As we’ve noted in the past, expanding breadth is one characteristic of a healthy stock market.

As noted above, about 82% of companies have topped analyst estimates for third-quarter 2021 earnings. Over the last five years, the average beat rate has been 76%.

About 75% of companies have exceeded 3Q:2021 revenue estimates. The 5-year average for this metric is 67%.

In general, third-quarter earnings have been solid but not quite as strong as second-quarter earnings.

Fixed Income Takeaways:

After moving up near 1.70% last Thursday, the 10-year Treasury note yield has dropped slightly over the past few trading sessions and was trading at 1.63% early on Monday.

Last Friday, Federal Reserve Chairman Jerome Powell commented that inflation might be a bit more persistent due to worsening supply-side constraints than earlier expected. At the same time, Powell does not believe that the time for interest rate hikes has arrived. Asset purchase tapering seems imminent, however.

Investment-grade (IG) corporate bond supply has been very heavy in October and is pricing into very strong demand. Credit spreads were stable last week despite this hefty supply, and most new deals are moving tighter in spread after initial pricing.

BBB-rated issuance has comprised over 80% of the volume in the IG new-issuance market this year. Due to very attractive financing terms for corporate debt, many large issuers have decided to add additional debt to their balance sheets.

BBB-rated issuers likely have more substantial balance sheets and more favorable credit metrics now than BBB-rated companies did in the past. Many of these issuers were able to retire higher-coupon debt with new issuance. Many also maintain sizable cash balances.

General Takeaways:

Economic data on balance remains positive, but growth rates are slowing – this describes the general theme from the Federal Reserve’s most recent Beige Book report, released October 20th.

The Conference Board Leading Economic Index (LEI) also continued to grow, but at a slowing pace. The LEI rose 0.2% in September, following an 0.8% increase in August and a 0.9% increase in July. That said, the Conference Board is still predicting 5.7% year/year growth for 2021 and 3.8% for 2022.

Housing data was mixed but, on balance, remains strong. Building permits and housing starts were both slightly below expectations. However, seasonally adjusted existing home sales rose 7% in September from August, with all regions showing an increase. Inventory declined 13% year/year (supply is tight). The median existing-home sales price rose 13.3% year/year to $352,800.

COVID-19 cases continue to decrease, and the 7-day moving average of cases is now under 75,000 – back to late July levels. Hospitalizations also continue to decline. According to the CDC, about 66.9% of the population over the age of 12 is vaccinated as of 10/21/21, up from 60.5% on 8/25/21.

The share of components of the Consumer Price Index (CPI) that have risen above 3% year/year is now 62% – inflation is becoming more broad-based. Much of the recent rise in inflation has been driven by “core goods” price increases. Shelter prices, which comprise approximately 33% of the total CPI, continue to rise.

On October 19th, an exchange-traded fund with exposure to Bitcoin was launched, which helped drive the price of cryptocurrencies higher. This week, Key Private Bank published a comprehensive piece entitled Cryptocurrency Basics: Blockchain, Bitcoin and Betting on the Future.

Equity Takeaways:

US stocks were mixed in early trading on Friday, while commodities were broadly higher. The S&P 500 was flat, while the tech-heavy Nasdaq fell about 0.5%. Small caps rose about 0.25%. International shares also rose slightly.

About 25% of the S&P market capitalization companies have already reported earnings. Earnings misses are being punished more by investors than earnings beats are being rewarded.

Next week will be among the busiest of earnings season. We continue to favor companies with pricing power and will continue to listen to what companies have to say about increasing cost pressures.

Fixed Income Takeaways:

The Treasury curve continues to shift higher in yield. Short-end yields have remained relatively stable over the past month; however, the intermediate portion of the curve has shifted higher. 3-year Treasury yields have increased 19 basis points over the past month.

The 10-year treasury yield traded at 1.66% in early Friday trading, down 4 basis points on the day, but about 40 basis points higher since late July. The high print on the 10-year treasury yield during 1Q:2021 was 1.74% – this level will be an important resistance level going forward.

This week was extremely busy in terms of new issuance. Dealers had expected about $20B of supply in the new issue investment-grade (IG) corporate bond market. Instead, we saw about $50B of new deals price into very strong demand.

This week saw $3.8B of positive flows into IG corporate bonds, after about $1B of positive flows the prior week. High-yield bond funds also saw positive flows after two weeks of outflows.

High-yield bond investors may be responding to increasing yields. At one point recently, the high-yield index traded as low as a 3.5% yield. The yield on the high-yield index is currently closer to 4.1%.

The municipal bond market softened yesterday. Yields increased about 5 basis points across the curve. Despite the recent cheapening, 5-year municipals still only yield about 50% of comparable treasuries (still expensive relative to history).

Congress continues to wrangle on two infrastructure bills, a $1B traditional infrastructure bill, and a larger social infrastructure bill. There are some positive provisions for municipal bonds in this legislation, so we will continue to watch for progress and will update clients are more information becomes available.

General Takeaways:

The current state of play:

1. Inflation rising (possibly at a slower pace, but not reversing quickly).

   The headline US Consumer Price Index (CPI) number remained high at 5.4% year/year in September, but the rate of change of the Core Goods CPI slowed to 0.25% month/month in September, from over 2% month/month during the spring.

   Similarly, US cargo shipping rates have dropped from record highs, perhaps in correlation with declining COVID-19 case counts. To be clear, however, things aren’t getting materially better, but things may not be getting materially worse.

   Workers seem to be gaining more bargaining power, as evidenced by an increasing number of strikes and labor shortages across the globe.

2. Fed tapering is expected to begin in November at a gradual pace, for now. What happens with inflation will be critical.

3. Congress is back in session and still dithering.

   The next important date in the debt ceiling debate appears to be December 3rd.

   A $1.2 trillion infrastructure bill, as well as a $1.5-$2.0 trillion social infrastructure bill, are still expected to pass Congress by year-end.

4. Chinese economic growth slowed to 4.9% for the recently ended quarter. This marks a notable slowdown, but some view this as temporary and driven by electricity shortages and supply-chain problems, which have weighed on the Chinese economy.

   Recent reports indicate that Chinese policymakers may consider loosening credit conditions (rate cuts, etc.) in an attempt to lessen the burden of the slowing economy on consumers.

   Opportunities for investing in China may best be found outside of passive indices.

5. US corporate profits remain strong.

   About 10% of the S&P 500’s market capitalization has reported earnings, with a significant majority of companies beating analyst estimates on both the top and bottom lines.

   ESG (Environmental, Social and Governance) Investing Update:

   On October 13th, the US Department of Labor proposed a new rule entitled “Prudence and Loyalty in Selecting Plan Investments and Exercising Shareholder Rights.”

   This rule is designed to remove barriers to considering ESG factors in ERISA retirement plan management.

   The proposal reverses prior guidance from the Trump administration, which passed approximately one year ago

Equity Takeaways:

US stocks were essentially flat in early trading on Monday. The S&P 500 was unchanged, while small caps rose 0.25%. International stocks dipped slightly.

Last week, the S&P 500 gained 1.8%. Late-October through the end of the year tends to be a seasonally strong period for the market.

Investors are closely watching oil prices, which are at their highest point since 2014 and have increased approximately 35% since late August. Consumer confidence surveys are also beginning to show concern around energy prices.

The growing consensus is that elevated energy prices could continue throughout 2022. Energy and supply-chain shortages are affecting companies throughout the world (China, Europe, UK, etc.).

Different sectors are exposed to the risk of rising energy prices in different ways. Going forward, analysts will focus on the potential impact of energy and supply chain issues on corporate margins.

With about 10% of total S&P 500 market cap reporting, about 80% of S&P 500 companies have beaten 3Q:2021 earnings estimates, compared to 86% in the second quarter. About 76% of companies have beaten revenue estimates, compared to about 83% in the second quarter.

Sentiment surrounding technology shares has begun to sour. The sector's price/earnings ratios remain elevated relative to history, and a rising rate environment tends to be a headwind for technology stocks.

Fixed Income Takeaways:

The intermediate portion of the Treasury curve is moving higher in yield this morning. The 3-year Treasury yield rose another two basis points to reach 0.71%. A year ago, the 3-year Treasury yield was about 0.20%.

Two important fixed income indicators, the shape of the yield curve and corporate credit spreads, indicate continued economic strength.

The yield curve is still solidly positive (long-term yields above short-term yields), although it has flattened somewhat recently due to rising short- to intermediate-term yields.

Corporate spreads tightened in both investment-grade (IG) and high-yield bonds last week. Strong demand for corporate credit continues, although activity typically tends to slow somewhat during earnings season.

Federal Reserve (Fed) governors appear to be united on asset purchase tapering but divided on many other aspects of monetary policy. Tapering is expected to be officially announced in November and is expected to be completed in May-June 2022.

Fed Chairman Jerome Powell continues to make the distinction between the Fed’s criteria for tapering vs. fed funds rate hikes. The phrase “tapering is not tightening” gives a good summary of current Fed guidance.

General Takeaways:

The September Federal Reserve (Fed) meeting minutes were released this week. The minutes revealed no significant changes from previously published comments, although the minutes took on a slightly more hawkish tone. Asset purchase tapering by the end of the year still seems likely. The Fed’s next meeting is in early November.

The JOLTS survey published by the Bureau of Labor Statistics still indicates a high number of job openings relative to history. Small businesses continue to report trouble filling open positions and are being forced to raise wages as a result. Last week, US initial unemployment claims fell below 300,000 for the first time since the pandemic began.

In addition, according to a recent survey by the National Federation of Small Businesses (NFIB), about 2/3 of companies are experiencing either significant or moderate supply chain issues.

Inflation Update:

The September Consumer Price Index (CPI) report was released. The year/year change ticked up to 5.4%, from 5.3% the prior month. Core CPI increased 4% year/year, in line with expectations. Producer prices (PPI) also continued to rise, with core PPI rising 2.9% year/year.

Average hourly earnings rose 4.9% (3-month annualized rate) in the United States, a 40-year high for this metric. Commodity prices continue to increase as well. The Bloomberg Commodity Index has risen about 76% from its pandemic lows.

Inflation is also affecting international markets. The UK continues to have supply chain issues/labor shortages, exacerbated by continued Brexit pressures on trade with the European Union.

Germany, the manufacturing hub of Europe, is also experiencing labor shortages and worker strikes. German business expectations have dropped to pre-pandemic levels.

Japan is also experiencing supply-related consumer price increases affecting eggs, dairy, coffee, etc. It has been many years since Japanese consumers have experienced price inflation.

Chinese producer prices (PPI) rose 1.2% in September and 10.7% year/year (a record high). Nevertheless, Chinese CPI rose only 1.2% year/year. China remains the world’s largest product exporter and is generally able to pass higher commodity costs onto overseas buyers.

COVID-19 Update:

The Delta wave appears to have peaked around September 1st. The 7-day moving average of cases continues to decline, along with hospitalizations.

Equity Takeaways:

Stocks rose in early Friday trading. The S&P rose about 0.7%, while small caps rose over 1%. International shares also rose.

Yesterday saw a significant move higher in the S&P 500, with the index rising 1.7%. It appears that the S&P 500 is putting in a near-term head & shoulders bottoming formation. 4465 is a key resistance level. If 4465 is cleared, the setup looks positive going into the seasonally strong fourth quarter.

About 10% of the S&P 500’s market capitalization has reported 3Q:2021 earnings. On balance, earnings have beaten expectations, led by the financial sector. This earnings season will play out over the next three to four weeks. If the current "beat rate" continues, 3Q:2021 earnings will have grown by over 30%, which should help underpin the stock market.

Leadership within the stock market has a cyclical tilt. Supply chain problems are affecting specific traditional cyclical sectors (industrials, materials). The financial, energy, and REIT sectors are leading the market. Growth stocks are lagging on a relative basis.

Fixed Income Takeaways:

At one point earlier in the week, the 10-year Treasury yield topped 1.60% before dropping back down towards 1.52% throughout the week. Friday morning, the 10-year yield was 1.57%, 5 basis points higher on the day.

Corporate credit spreads remain well behaved, and Investment-grade (IG) spreads moved slightly tighter on the week. Investors are showing a high appetite for new deals, especially from financial companies, with these deals seen as a hedge against rising inflation.

High-yield bonds tend to be correlated with equity prices. With the strong rally in stocks on Thursday, high-yield bonds put in their strongest daily performance in 5+ weeks.

Municipal bond inflows picked back up over the past week after a slight pause. Money is flowing out of high-yield municipal bond funds and into higher-quality funds. Overall, the pace of inflows has slowed.

Secondary municipal trading activity is increasing and is concentrated towards the front-end of the curve. 1-year municipal bonds yield about 120% of comparable Treasuries, which is relatively cheap. 3-year municipals yield about 37% of comparable Treasuries, which is quite expensive.

General Takeaways:

Employment update: September US non-farm payrolls disappointed, rising 194,000 vs. expectations of over 500,000. The prior month was revised upwards by 131,000 jobs.

The US labor market is still tight. According to the National Federation of Independent Businesses (NFIB), job openings abound, companies are being forced to raise wages. In addition, an increasing number of worker disputes and strikes are adding to the disruption in labor markets around the globe (including Germany).

Despite choppiness in the labor market, surveys of trucking activity continue to indicate strong GDP growth. The path to growth may contain fits and starts, and companies seem to believe that supply chain issues will not normalize until the second half of 2022 (later than prior expectations).

The Senate approved a bill to raise the US debt ceiling to avert default. However, the extension seems to be for only about six weeks (until approximately early December). The government is now expected to run out of funding between two important Federal Reserve (Fed) meetings.

COVID-19 Update: Cases continue to decline, and it appears that the recent Delta wave spike has likely peaked. Vaccinations continue to increase modestly. Approximately 66% of the US population over the age of 12 has been vaccinated.

China update: there has been no change to US/China trade policy after the election of 2020. For a reduction in tariffs to occur, more communication needs to happen between the US and China.

October 1st was National Day, the birth of the People’s Republic of China in 1949. China flexing its muscles over Taiwan is not surprising during this patriotic “Golden Week” celebration. Taiwan’s National Day is October 10th, so their recent response likely does not portend an impending skirmish.

Equity Takeaways:

After some initial volatility after this morning’s non-farm payrolls report, equities settled back into their range before the report. US stocks were essentially flat in early trading, while international stocks (both developed and emerging markets) rose about 0.25%.

After the employment report, the US dollar weakened slightly, resulting in a rally in precious metals, with gold rising over 1%.

Implied volatility (VIX) declined Friday morning. After trading around 20 overnight, the VIX was 18.9 in early Friday trading. Market participants seemed to anticipate some volatility in the non-farm payrolls number and were not surprised by the lower-than-expected print.

The European Central Bank (ECB) remains adamant that the recent spike in Eurozone inflation is transitory (likening it to a “sneeze”). After the Great Financial Crisis of 2008-2009, the ECB overestimated inflation, and they don’t want to make that mistake again. Unlike their central bank counterparts in the US and UK, the ECB is not planning any tapering of asset purchases.

Fixed Income Takeaways:

The yield curve steepened this week, with the 10-year Treasury note yield rising to 1.60% in early Friday trading. Yields initially moved lower after the non-farm payrolls report but quickly reversed higher.

We don’t believe today’s employment report will prevent the Fed from announcing a tapering of asset purchases at their November meeting. The unemployment rate dropped to 4.8% in September (partially reflecting a drop in the labor force participation rate). In short, today’s report was likely strong enough to allow the Fed to stick to its current plan.

We continue to see unusual trading activity within the Treasury-bill markets. Treasury bills with certain maturities near the impending debt ceiling deadline are trading at slightly higher yields due to concerns about technical default provisions.

Investment-grade (IG) corporate bond funds saw significant outflows this week (the largest since April 2020) after eight consecutive weeks of inflows. Concerns about inflation and the debt ceiling debate likely caused investors to pull funds from the corporate bond markets.

Municipal bond fund flows have also begun to moderate. High-grade municipal funds saw essentially flat flows on the week, while high-yield municipal funds saw outflows.

Municipal secondary trading activity, which is down 35% year/year, is also beginning to pick up with the recent increase in volatility.

General Takeaways:

1. Washington Update

   - As we reported on Friday, the $1 Trillion Infrastructure Bill has been tabled; over the weekend, no progress was made, and as a result, the status remains the same.

   Regarding the $3.5 trillion spending bill, on Friday, it seemed the outcome was way up in the air; over the weekend, it appears the direction of negotiation is now trending toward a $1.5 trillion package. Senator Joe Manchin (D-WV) referenced prior talks earlier this year with Democratic party colleague Chuck Schumer (D-NY) that provided an outline/agreement for spending at the $1.5 trillion level.

   - The deadline for government funding was extended to December 3rd.

   - The debate on the debt ceiling continues to loom larger with respect to the timing of the resolution before October 18th, which is now only two weeks away. The last time something similar occurred on the debt ceiling was in July 2011, when the US Government experienced a debt downgrade.

   The S&P 500 Index lost 9.8% in the month before the downgrade and declined another 2.5% in the month following.

   Over the next 3, 6, and 12 months, the market recovered with positive returns of 5.3%, 12.1%, and 16.3%, respectively.

2. COVID-19 Update

   - On Friday, Merck and Ridgeback Biotherapeutics announced early results of an oral antiviral (“Mjolnir”) that reduced the rate of deaths and hospitalizations among newly diagnosed COVID patients by roughly 50%, including those with the variants Delta, Gamma, and Mu.

   The early results among 729 patients were so promising that an independent data monitoring committee, in consultation with the FDA, recommended the study be stopped so as not to injure those in the placebo group unnecessarily. Merck will now seek emergency use authorization for the drug, and they have already begun discussions with generic drug manufacturers to produce significant quantities of the drug globally.

   If confirmed, this could make the virus “treatable” like the flu and could have significant, positive impacts on the ability of the global economy to return to normal.

3. China

   - Over the weekend, it appears China has stepped up efforts to limit contagion of the China Evergrande situation without necessarily intending to save the company.

   - China Evergrande is also trying to raise external capital to provide liquidity. It’s too early to tell exactly how this plays out, but it will have some impact on China’s economy and slow the country’s economic output.

   - In addition, China is affecting its own energy prices by limiting and/or rationing electricity, which has implications for inflation and other items.

   - Lastly, over a longer time period, we believe China is too big to ignore as it represents approximately 20% of global GDP and has vastly expanded its trading partners with many countries around the world. From a pure portfolio diversification perspective, it remains an attractive opportunity. Also, investors should not forget that even if the economy is slowing and faces demographic challenges, China’s middle-class is still rising noticeably, which portends a potential tailwind for growth over the next few decades.

4. US Economy continues to boom

   - Salaries and wages increased 5.7% at a month/month annual rate, and spending increased at a 10.4% annual rate.

   - Savings rates are coming down, but consumers are still flush with +$2 trillion in savings due to rising home prices and investment portfolio values.

   - Manufacturing activity reaccelerated and beat forecasts, with indicators continuing to show expansion. Supply chain delivery times remain elevated but eased slightly over the past month.

   - On Friday, inflation expectation data also remained elevated and has not changed much since last month, with one-year forward expectations hovering at around 4.6% and longer-term (5-years +) expectations at approximately 3.0%, which is at the upper end of historical ranges, rather than at a level considered worrisome.

   - Third-quarter earnings season starts next week and will be an important one. Estimates have come down slightly, and several factors should be considered:
   (a) supply chains
   (b) labor costs
   (c) energy prices
   (d) Washington DC uncertainty
   (e) and China uncertainty

Equity Takeaways:

US equity markets were down in early Monday trading. The S&P 500 declined 1.4%, while the NASDAQ slipped further, down 2.2%. Small caps also retreated, losing 1.0%.

Last week ended well, but the S&P 500 was still down 2.2%, representing the 18th weekly loss of at least -2% since the start of 2019. During this time frame, the benchmark index was higher the following week 12 of 17 times (71%-win rate) with an average move of +2.1%.

Also, since the start of 2019, there have been back-to-back -2% weekly declines twice: the weeks ending 9/4/20 - 9/11/20 and 3/13/20 - 3/20/20. Both sets of consecutive declines happened during the two largest drawdowns experienced over the last two calendar years.

That makes this week a rather important one. If we stabilize here, then a resumption of the bull move is likely imminent; however, another -2% decline could be a harbinger of a deeper correction unfolding.

Wall Street analysts have been cutting their third-quarter US corporate earnings expectations for four straight weeks now, and the trend has begun to spill over into their 4Q expectations as well. These are not top-down guesses based on macro inputs, such as the estimates that come from the Street’s strategists – instead, they are the result of adding up every consensus estimate for all 500 companies in the S&P Index.

Clearly, a subdued backdrop as we head into the lull before earnings season truly kicks off on October 13/14. Note: analysts have been excessively cautious on US corporate earnings power all year, suggesting that the market believes we are heading into another reporting period where results will far exceed expectations. Time will tell.

Historically, correlations between the S&P500 Index and bond prices have been negative, which bodes well for portfolio diversification and a typical 60/40 portfolio of stocks/bonds. More recently, correlations have hit a 14-year low (1-year) and are problematic because yields are low. While we are not concerned to any degree right now, it is something that bears watching.

Fixed Income Takeaways:

Treasury yields experienced a bear-steepening this morning, with the 10-year treasury yield increasing 2 basis points (bps) higher to 1.47%, while the 2-year treasury remained unchanged. This continues the steepening that we saw last week with yields down on the front-end and belly of the curve, as the long end saw yields move higher.

All eyes this week will be on the payroll data to be announced on Friday. This will be telling on the direction the Federal Reserve (Fed) may take.

Credit spreads remain well-behaved. Investment-grade (IG) spreads were unchanged on Friday and almost 3 basis points wider for the week. High yield spreads were about 4 basis points wider on Friday and nearly 17 basis points wider for the week.

We expect approximately $20 billion in IG new issuance for the week and $100 billion for October. We anticipate issuers will continue to come to market under the premise that interest rates will move higher in the last quarter of the year and want to take advantage of where rates are now.

Flows into IG funds have been strong this year, with 32 consecutive weeks of inflows.

Demand for the Fed’s overnight reverse repo facility is poised to resume today after a drop last week due to quarter-end. Volumes are expected to increase this week. Investors are demanding more yield for bills due in late October due to the debt ceiling remaining unresolved.

Eighteen of the FOMC members commented last week and centered around support for tapering, likely to be announced in November. Inflation and rate lift-off expectations remained more dovish.

General Takeaways:

The third quarter of 2021 ended yesterday and generally followed its tendency for seasonal weakness. For the month, global stocks fell 4.1%, while US stocks dropped 4.7%. Global bonds fell around 0.9%. Year to date, global risk assets are still in the green, while global bonds continued at around –1%.

Meanwhile, earnings are getting cheaper but are still elevated. There are not many signs of stress in corporate bond spreads (a measure of market risk). However, credit default swaps have widened, most likely due to political volatility in Washington DC.

This week, there was much noise from Washington, including discussions over the pending infrastructure and spending bills and the looming debt ceiling. While the odds of a deal have fallen, we believe it is still the most likely scenario because failure is not an option. While we endure this volatility, we remind investors to tune out Washington – and the media – as much as possible until the ink is on paper.

On the monetary front, eyes are on the Federal Reserve leadership as Jerome Powell, and seats within the Fed board come up for re-nominations.

The story of the year continues to be inflation. As we mentioned in our 2021 outlook, “after a demand shock, COVID created a supply shock. With many key goods in short supply, inventories are lean. Too, resiliency is replacing efficiency, and ‘just in time’ is replacing ‘just in case.’ This is a recipe for inflation.”

Stocks have traditionally faced valuation headwinds when inflation crests above 4%. We're getting closer to that number. Inflation expectations going forward are elevated but still contained. On the plus side, price increases lift company revenues and profits, and wage increases lift consumer incomes.

It seems that supply chain bottlenecks could continue to put pressure on upward inflation. If this is the case, the Fed may have fewer tools in its toolkit to limit inflation. However, Powell continues to emphasize that he believes this is a temporary phenomenon.

Finally, we remind clients of the upcoming national calls:
October 7 @ 3:00 pm ET – National Client Call focus on China
October 12 @ 2:00 pm ET – National Client Call focus on potential Tax Changes

Equity Takeaways:

The month of September held true to form in its traditional stock weakness. The S&P 500 was down 4.8%, its worst month since March 2020. Even with the September weakness, 412 companies within the 500-company index ended in the green year to date going into the final quarter. We also suspect earnings estimates will be less confident this quarter due to supply chain pressure and looming inflation.

Within international markets, the European Central Bank (ECB) and Bank of Japan (BOJ) continue to signal accommodative policy, while the Bank of England (BOE) signals a more hawkish stance. We also saw recent elections in both Germany and Japan. In Germany, the plurality landed with a center-left lean, while Japan saw a new figurehead in Fumio Kishida, though continued leadership by the Liberal Democratic Party.

In China, Evergrande ripples continue to work their way through markets. It seems that onshore (not offshore) investors are advantaged in the bond market.

Fixed Income Takeaways:

US Treasuries rose across the yield curve in September in what’s been called a delayed taper tantrum. Treasury markets saw their biggest losses since March 2020. The 10-Year Treasury spent most of September in a holding pattern, around 1.30% - 1.36%. Amid continued corporate bond issuance, crude oil spikes, UK yields increasing, and upcoming payroll numbers, eyes will be watching the 10-Year. Even with this volatility in the market, spreads have been resilient, and the demand for corporate credit continues.

In the municipal market this week, munis cheapened in sympathy with Treasuries. Inflows were still positive, but the pace has slowed a bit. For the year, average weekly inflows stand around $1.5 billion; this week, inflows were about a third of that. High yield muni funds had outflows of $100 million. The muni market stands ready to finance the potential $1 trillion infrastructure bill, but as mentioned, the ink has to hit paper.

General Takeaways:

Four Things We Learned Last Week:

1. China’s economy will slow.
   • While broad market reverberations may be felt, Key Private Bank does not believe that the Evergrande situation will cause global systemic risk to the financial system.
   • We also do not expect a state bailout of Evergrande, which would undermine the Chinese government’s deleveraging campaign and cause moral hazards in China’s property development sector.
   • Markets are digesting this news in an orderly fashion (watch onshore vs. offshore Chinese share performance – offshore shares remain near all-time highs).
2. The Federal Reserve (Fed) will likely begin raising interest rates next year.
   • Asset purchase tapering is not tightening, but the difference will be measured in months, not years.
   • The vote is currently split within the Federal Reserve Open Market Committee (FOMC) on rate hikes in 2022, but voting members will change.
3. Fiscal policy remains highly uncertain.
   • There are currently two stimulus packages working their way through various stages of Congress – a $1 trillion stimulus bill and a $3.5 trillion spending bill.
   • Government funding expires on October 1st at 12:01 AM. According to PredictIt.org, the odds of the debt ceiling being raised by October 1st are almost nil. Debt ceiling issues typically do not initially cause significant market moves, but a long, drawn-out process could weigh on markets over time.
   • The current corporate tax rate is 21%. Market expectations are for a 2022 corporate tax hike into the 24.6% - 27.9% range; however, much uncertainty remains.
4. COVID-19 may be with us for a long time, but it can be managed via vaccination.
   • The audio replay/slides of our recent client call with Dr. Stephen Thomas, MD, are now available. The call was entitled “COVID-19 Update – The Public Health and Economic Impact of the Delta Variant.” Please contact your Key Private Bank advisor for details.

A longer winter has reduced global natural gas reserves to about 25% below the historical average. Supply issues have been exacerbated as demand continues to increase. In Europe, Russian natural gas exports were disrupted by a large fire in Siberia. Norway, another large supplier, has had construction-related delays.

The energy shortage has led to gasoline stations shutting down across the UK. In addition, electricity bills in Europe have increased exponentially due to seasonal wind turbine repairs, lower coal production, and increased Chinese demand.

Most energy analysts believe these issues are temporary and should be resolved by the end of 2021 or early 2022.

Equity Takeaways:

Stock prices were mixed in early Monday trading. The S&P 500 fell about 0.25%, while the tech-heavy Nasdaq fell over 1%. Small caps, however, rose nearly 1%, while value stocks also rose.

Technology shares are likely reacting negatively to rising interest rates. Conversely, sectors such as financials and industrials are prominent within value indices. Financials benefit from rising interest rates and a steeper yield curve.

Despite heavy volatility last Monday, the S&P 500 rose 0.5% last week, and through the close on 9/24, it is up about 20% year-to-date (YTD).

The S&P 500’s “Weakest Week” did not disappoint. At last Monday’s intraday low, the recent peak to trough drawdown totaled -5.3%. There have now been six pullbacks of at least 3% in 2021, the average of those being -4.5%.

The S&P 500 broke below its 50-day moving average last week. This type of price action has occurred several times since the March 2020 lows, and each time the index was able to quickly rally back above its 50-day moving average.

S&P 500 breadth improved during the middle of last week. Overall, 55% of S&P 500 stocks were positive on the week, the first positive showing in three weeks. Breadth remains soft overall and needs to improve for the market to rally back towards all-time highs.

Wall Street analysts continue to cut their aggregate third quarter 2021 earnings estimates – these estimate cuts have likely contributed to the recent market weakness. The current third-quarter estimate of $48.93 for aggregate earnings is 7% below second quarter 2021 actual earnings of $52.80 and roughly equal to the first quarter2021 actual earnings of $49.03. Strong earnings will be critical to market performance in the coming weeks and months.

For the first time in 16 years, Germany will have a new leader, with a centrist-left coalition likely to assume power. Right now, the global equity markets appear to be treating this election as a market-neutral event.

Fixed Income Takeaways:

10-year US Treasury yields rose 9 basis points (bps) last week and were up another 5 bps Monday morning to 1.50%. These are the highest levels since June.

It is possible that bond market participants are viewing last week’s Federal Reserve testimony as more hawkish than expected – a delayed “taper tantrum.”

With volatility in the stock markets and interest rates last week, new investment-grade (IG) corporate bond issuance was muted last week, with only about $16 billion pricing (compared to expectations of $25 billion). Expectations are for about $20 billion of IG issuance this week.

Even as Treasury yields rise, IG spreads continue to tighten. High-yield bonds also continue to trade well, with the high-yield index recently trading at a yield of 3.89%. High-yield bond spreads are near 14-year lows.

General Takeaways:

1. Economic Releases
   - Housing data was steady, indicating a market showing continued strength.
   - Leading indicators continued to improve.
   - Unemployment claims rose slightly. However, the 4-week moving average remained stable.

2. COVID-19 Update
   - The 7-day averages of both cases and hospitalizations have inflected lower. The peak of the Delta outbreak appears to have occurred in late August.
   - Over the past month, US vaccination rates increased marginally. In the over-age-12 population, 64.3% of the US is now fully vaccinated, up from 60.5% in late August.

3. Federal Reserve (Fed) Open Market Committee Highlights
   - On balance, Fed governors became marginally more hawkish during the September meeting. Due to continued economic improvement, it seems highly probable that the Fed’s “substantial further progress” test has been met, and asset purchase tapering will be announced at the next Fed meeting in November. More details are below.

4. China Evergrande Group
   - Evergrande is one of China’s largest and most-levered real estate developers. The Chinese government recently tightened credit conditions, which is affecting Evergrande’s business model.
   - Despite its heavy debt load of $300B, we do not believe the Evergrande situation represents a systematic risk to the global financial system. China’s government has the financial capacity to bail out Evergrande at any time (if they so choose).
   - Earlier this week, China injected a substantial amount of short-term funding into the banking system, essentially injecting stimulus into the economy to help offset the Evergrande situation.
   - Many of the Chinese citizens affected by Evergrande’s collapse are middle-class homeowners.

   Recently, Chinese policy has been directed at closing the wealth gap, so the government will likely provide some form of support to affected home buyers.

5. Cryptocurrencies
   - A prominent investment firm plans to create Exchange-Traded-Funds backed by bitcoin and other cryptocurrencies.
   - The SEC’s Gary Gensler does not see cryptocurrencies lasting, recommending increased oversight for trading platforms and stablecoins.
   - China banned cryptocurrency nationwide, ruling the currencies illegal. Bitcoin prices dropped about 6% on the news. China is preparing its own yuan-backed digital currency.

Equity Takeaways:

US equity markets were flat to slightly lower in early Friday trading. The S&P 500 was essentially unchanged, while small caps dipped slightly. International markets, both developed and emerging, were both about 1% lower.

After Monday’s sharp selloff, US equities staged a strong rebound during the Wednesday and Thursday sessions, with the S&P 500 rising about 1% both days. That said, breadth (as measured by the NYSE Cumulative Advance-Decline Line) remains relatively soft. We would like to see the recent all-time high in the S&P 500 confirmed by rising breadth.

The dollar was stronger in early trading, while commodities were mixed.

Fixed Income Takeaways:

Treasury yields moved higher yesterday, with the 10-year Treasury yield increasing almost 10 basis points (bps). Early on Friday, the 10-year yield traded at 1.45%, its highest level in several months.

This week, the Bank of England struck a hawkish tone with some members voting to end Quantitative Easing (QE) earlier than expected due to inflation fears. UK gilt yields rose as a result, which is one reason US Treasury yields also rose yesterday.

Conversely, corporate bond spreads tightened yesterday and have remained very orderly throughout the week. During Monday’s turbulence caused by the Evergrande situation, investment-grade (IG) corporate bond spreads widened 3 basis points but retraced that move by tightening throughout the subsequent week.

As noted above, the Fed is likely to begin asset purchase tapering by the end of 2021. That said, on balance, Fed policy remains accommodative, and the Fed remains committed to achieving maximum employment.

FOMC governors/bank presidents are now split between a 2022 or 2023 liftoff in the Fed Funds rate. Of participants providing projections, 9 out of 18 now see the initial rate hike occurring in 2022, whereas 7 held that view at the June meeting.

The Fed increased its internal projections for 2021 and 2022 inflation. Long-run inflation projections remained essentially unchanged. 2021 GDP growth projections were revised slightly lower, while 2022 growth projections were revised higher.

Municipal bond mutual funds continue to see persistent inflows. Municipal bond rates increased 2-3 basis points across the curve this week but remain expensive relative to treasuries.

Recently, Key Private Bank published a Key Questions article discussing recent dynamics in the municipal bond market.

General Takeaways:

According to Evercore ISI data, corporate survey data (an important leading indicator) has softened over the past few months but remains strong on an absolute basis. The slowdown is likely driven by near-term supply issues, not demand issues, as indicators such as retail sales and freight rates still indicate robust demand.

There have been four “growth scares” since mid-2010, during which the economy experienced a pullback in growth expectations. These “growth scares” each saw a short-term market decline of over 10% during a several-month period, but each turned out to be a long-term buying opportunity.

If the yield curve stays positive and credit markets remain stable, we expect any current choppiness in the stock market will likely resolve similarly to previous “growth scares,” with temporary weakness followed by long-term strength.

Inflation remains a wild card to the economic outlook, and several measures of consumer inflation expectations continue to increase. That said, productivity and corporate profitability also remain strong, with corporate survey data indicating continued pricing power across various sectors.

A Chinese property developer named Evergrande is under severe stress, and this stress is reverberating through the Chinese economy. To this point, the Chinese government does not appear poised to bail out Evergrande. Instead, the Chinese government is clamping down on home prices and tightening real estate credit conditions.

COVID-19 Update: Key Private Bank has a special national client call scheduled for Tuesday, 9/21, at 3:00 PM ET with Dr. Stephen Thomas. Dr. Thomas is the Chief of the Division of Infectious Diseases and Director for the Institute for Global Health.

Equity Takeaways:

Stocks declined sharply in early Monday trading. The S&P 500 dipped about 1.25%, while the Nasdaq fell about 1.75%. Small caps also dipped sharply. Emerging market equities fell over 3%.

The above-referenced Evergrande situation in China has caused significant weakness in the US stock market on Monday morning, as investors fear a systemic global credit event. To this point, US credit spreads have remained stable, but stock market participants tend to sell first and ask questions later during these types of events.

In addition, corporate earnings forecasts have flattened out for the back half of 2021, creating another headwind for the markets. The third quarter 2021 earnings season will thus be very important. We continue to believe that third-quarter earnings should come in very strong.

Last week, the S&P 500 declined about -0.57%, which is only the fifth time since the March 2020 lows that the index followed a weekly 1% decline with a loss the following week. The index was choppy, posting three 1% rallies and four 1% declines during the week, but overall, the index traded in a tight 1.3% range all week.

S&P 500 breadth was negative for the second straight week, with 59% of stocks declining. This number was an improvement on the prior week’s reading, where 84% of stocks declined.

The week following the 3rd Friday in September has the worst average returns (the “Weakest Week”) when measured over many time periods. This year we have experienced two weeks of selling before the “Weakest Week.” In 11 prior historical instances of this pattern, ten weeks saw further selling. In short, the seasonal pattern does not favor a bounce back this week.

Fixed Income Takeaways:

A flight-to-quality bid is supporting the treasury market early Monday morning. The 10-year Treasury note traded at 1.31%, 5 basis points lower from Friday. The Treasury curve flattened slightly.

Last week, investment-grade credit spreads closed at their tightest levels since late July. We are expecting issuance to slow this week due to choppiness related to Evergrande Group, the largest high-yield corporate borrower in the Asian region.

This week, credit market participants will be watching the Evergrande situation closely for any potential systemic risk to the Asian financial system and any potential spillover into global credit markets.

The Federal Reserve (Fed) will hold an important meeting this Wednesday, 9/22. We expect the Fed to possibly open the door to a possible November tapering announcement, contingent on continued strong economic data/labor market improvement.

The Fed’s 2021 inflation forecast is likely to be revised higher. In addition, we expect a possible slightly more hawkish “dot plot,” with Fed Fund rate hikes beginning in 2023. We don’t believe that the Fed will guide towards any rate hikes until 2023.

General Takeaways:

Economic data released this week was mixed but somewhat encouraging.

As measured by the Consumer Price Index, inflation showed increases moderating – for August, a 0.3% increase overall and an increase of 0.1% for core inflation, both down from July. The 12-month change from one year ago was up 5.3% overall and up 4.0% for core; compared to July, both prints were lower but remain elevated.

All significant components increased at lower levels than the prior month, except for energy, electricity, gasoline, and apparel.

We continue to see inflation in other areas as well, particularly in commodities. Uranium, aluminum, lithium, and natural gas (in Europe) have shown significant increases in the past 12 months.

Empire State Manufacturing PMI – General Business Conditions improved in September, increasing 16 points to 34.3. The reading was well above average and indicative of robust output growth. New orders, shipments, and unfilled orders all increased substantially. Labor market indicators pointed to strong growth in employment and the workweek.

Philadelphia Fed: Current Indicators improved in September, increasing 11 points to 30.7. Firms reported increases in shipments, but new orders fell. On balance, firms continued to report increases in employment, but the employment index declined from 32.6 in August to 26.3 this month.

Retail Sales and Food Services: According to The Commerce Department advance estimates, increased in August by 0.7% ($618.7 billion) versus a decline of 1.8% in July. The 12-month change from August 2020 was +15.1%. Retail Trade Sales were up 0.8% from July 2021 and 13.1% over last year.

Initial unemployment claims ticked up slightly over the prior week, but the 4-week average declined. Ongoing claims continued to decrease as well.

Individual investors’ cash allocation dropped to the lowest level since 2000 when the tech bubble and growth mania collapsed. Today is a different environment, and a similar decline in stock prices is unlikely. As easy monetary policy has led to low yields, the extremely low level of cash may indicate how speculative the market has become and how susceptible individual investors are to any significant pullback in the market.

US COVID-19 cases increased over the prior week when the data showed a peak in cases. The 7-day moving average of cases is now at approximately 146,000 per day. Hospitalizations have peaked but may indicate a future increase following the uptick in cases.

According to a report published by Barron’s, Senate Finance Committee Chair Ron Wyden (D-OR) submitted proposals to change the way ETFs are taxed as part of the $3.5 trillion Biden bill being considered. ETFs are currently granted a tax “exemption” due to their structure – that differs from mutual funds – whereby investors do not pay tax on capital gains until the ETF is sold. Preliminary estimates show that repeal of such tax advantages could generate over $200 billion in additional tax income over a decade. Taxation of this type would be significantly disruptive for the ETF industry and would change the perspective on how investors utilize ETFs as part of their portfolios.

In addition, it appears the Biden administration would like to see corporate tax rates at 26.5%, below the original proposal of near 28.0%

Equity Takeaways:

On Friday, stocks were slightly lower in early trading, with the S&P 500 trading down by 0.8%, while small caps were essentially unchanged.

The negative market breadth we have discussed in recent weeks has not materially improved, although it has improved modestly within the NASDAQ.

Within the tech sector, we are seeing correlations break down a bit recently, which is surprising to us, given that when perceived macro risks increase, we tend to see more convergence with stocks moving in tandem. Links between stocks in the tech sector are currently at their lowest in three years.

We believe the opportunity for investment managers to pick stocks in this environment could prove favorable for alpha generation.

Fixed Income Takeaways:

US Treasuries opened today weaker by 3 basis points (bps), with the 10-year at 1.37%. Within the 5-year/30-year curve, we are about 8 bps flatter on the week. That brings us to 104 bps – a fairly big move – the last time we saw such a move was in mid-June, right after the Fed meeting. This most recent move may also be consistent with the anticipation of the September FOMC meeting next week.

European government bond yields remain higher this morning after internal ECB models pointed to faster inflation and a sooner rate hike than earlier expected. This could affect yields in the US.

Concerning credit spreads, it has been a consistent story. Over the past several months, credit spreads have remained well-behaved in this market. Yesterday, investment-grade spreads remained unchanged with an OAS of 86 basis points over US Treasuries. High yield spreads were 2 basis points tighter, with an OAS of 275 basis points. The high-yield market is looking to post its fourth consecutive week of gains. Junk bond yields are currently at approximately 3.75%, just 23 basis points above their all-time low of 3.53%.

With rates where they are, issuers continue to come to market in both investment-grade (IG) and high-yield. We saw $38 billion in IG new deals this week, taking the September total to $119 billion. Demand continues to be strong, with little to no concessions.

The municipal market continues to experience strong fund flows. Through the first 37 weeks of this year, fund flows represent the potential for all-time records in volume.

General Takeaways:

There have been 213 trading days since the last correction of 5% or more in the S&P 500. This streak is the 9th longest in the previous 90 years.

While it’s true that September is the weakest seasonal month of the calendar year, it is followed by some of the best calendar months (November, December, and January).

What could go wrong in the coming months to derail the market?

1. Growth slowdown:

   Negative economic revisions for 2021 GDP growth are currently offset by positive economic revisions to the 2022 outlook.

2. Earnings Slowdown:

   The trend in earnings is similar – estimates for aggregate 2021 S&P 500 earnings have recently been revised fractionally lower, but the trend in 2022 remains higher.

3. Tax Hike:

   A corporate tax increase is being contemplated in Congress. The current 21% corporate tax rate could move higher as part of an additional stimulus package. Provided that the overall economic backdrop is solid, tax increases generally do not immediately result in a weaker stock market.

4. Federal Reserve (Fed) Policy Mistake:

   Fed asset purchase tapering versus tightening via rate hikes. The yield curve will give essential clues on whether the Fed policy is becoming too tight. The yield curve tends to flatten/invert during an economic slowdown.

5. COVID-19:

   Despite the recent Delta variant outbreak, the Goldman Sachs US reopening scale is up to 9/10 (with 10 being pre-pandemic levels of activity). As we noted on Friday, both cases and hospitalizations seem to have inflected lower in late August. New variants are the wild card.

   Old Wall Street saying: “Markets stop panicking when policymakers begin to panic.” President Biden’s recent speech on COVID-19 could mark the inflection point of the recent outbreak.

6. Inflation:

   After freight bottlenecks earlier in the year, containerships have begun to arrive at US ports but are now having trouble unloading. Supply shortages continue in certain sectors as a result.

   The “Misery Index” is the sum of Consumer Price Inflation and the Unemployment rate. Historically, a Misery Index above 10% has corresponded with slowing growth and high inflation (aka stagflation). The current level of the Misery Index is 10.5%, but this number would likely have to stay above 10% for quite some time for stagflation to take hold.

2021 is on pace for record global private capital fundraising. Various strategies continue to attract capital, such as private equity, venture capital, private debt, secondaries, real assets, and real estate. Private oil and gas strategies continue to lag in terms of performance. Manager selection remains paramount among all strategies.

Equity Takeaways:

On Monday, stocks were slightly higher in early trading, with the S&P 500 trading fractionally higher, while small caps rose about 0.5%.

The S&P 500 declined every day last week and now has a five-day losing streak for the first time since 2/16/21-2/22/21, and for only the second time all year. The last longer streak happened from 2/20/20-2/28/20 (seven trading days). In addition, the S&P 500 endured its first weekly decline of at least -1% since the week ending 6/18/2021.

After a -1% weekly loss since the March 2020 lows, the Index has been higher the following week 11/14 times (79% hit rate), with an average gain of +3.2%. Additionally, there were consecutive weekly losses of at least -1% only once over that time frame (the weeks ending 9/4/20 and 9/11/20). More recently, in 2021, the S&P 500 has logged gains the next week 4/5 times (80% hit rate), with an average move of +1.9%. This suggests an upside bias this week.

Markets climb a wall of worry. Over the summer, we had a stealth correction underneath the market's surface, with the average stock declining over 7%.

Weekly S&P 500 breadth dropped to 84% negative (meaning 84% of SPX issues were negative for the week), one of the worst weekly internal readings all year. The index had negative daily numbers each of last week’s four days, with the S&P 500 Index’s cumulative advance/decline line now noticeably below the early September highs. We have highlighted bad breadth in our commentary since the end of July.

Key Private Bank continues to expect a strong finish to the year in the equity markets, supported by strong earnings. However, we continue to believe that the market could be choppy over the next 3-4 weeks. Seasonal patterns will begin to turn favorably in mid-October.

Fixed Income Takeaways:

The 10-year Treasury note continues to trade in a range, showing a 1.32% yield as/of Monday morning. The yield curve continues to flatten slightly due to declining yields on the long end.

After the Labor Day holiday, investment-grade (IG) corporate bond spreads tightened slightly despite heavy supply. Fifty-four issuers came to market last week, eclipsing the weekly record of 52 issuers. Money continues to pour into corporate bond funds to support this new issuance.

High-yield corporate bonds also had a strong week. Year-to-date (YTD), high-yield spreads are about 75 basis points tighter.

Talks of a delayed debt ceiling extension put some pressure on short-term money market instruments, including Treasury bills. The government’s ability to borrow in the Treasury bill market will be severely limited as we move through October without an updated debt ceiling.

Later this week, important inflation data will be released. Core Consumer Price Index (CPI) data will be released Tuesday. The Federal Reserve will be watching any incremental economic data very closely to inform their decision on tapering.

General Takeaways:

The Federal Reserve (Fed) Board Beige Book report was released on Wednesday, September 8th. Fed Districts generally reported that economic growth weakened slightly in August vs. July due to the COVID-19 Delta variant.

In general, the Beige Book noted continued business optimism, somewhat offset by supply disruptions and extensive labor shortages in some areas.

Non-farm payroll data weakened in August, with total payroll employment rising by 235,000, well below expectations. That said, the job market remains strong overall. As measured by the JOLTS survey, job openings remain high, and jobless claims continue to decline.

Despite the ongoing recovery in the economy, the labor force participation rate (LFPR) has not recovered to its pre-pandemic level. Before the COVID-19 recession, the LFPR was 63.3%. Currently, it is 61.7%, a difference of almost 5 million jobs.

COVID-19 update: According to the Centers for Disease Control (CDC), cases and hospitalizations both appear to have peaked in late August. The 7-day moving average of both cases and hospitalizations appears to have inflected lower.

According to “Our World in Data,” as compiled by Alpine Macro, most Americans have made up their minds about vaccination. The percentage of the population that is unwilling to be vaccinated has remained very steady since February 2021. With vaccination mandates increasing at both the federal and individual company level, personal decisions around vaccination will likely affect the labor market in the future.

Equity Takeaways:

US stocks moved higher in early Friday trading. The S&P 500 rose about 0.4%, with small caps up a similar amount.

President Biden held his first call with Chinese leader Xi Jinping in about seven months, which lasted about 90 minutes. Biden initiated the call, seemingly to reduce hostilities between the two countries. Market participants are viewing this discussion as a bullish signal from a diplomatic perspective.

A recent survey of economists shows that 70% believe the Fed will be forced to hike rates faster than expected, beginning in 2022. The stock market is not currently pricing in such a scenario.

The European Central Bank’s (ECB) September Governing Council meeting was this week. The group decided to pull back on incremental purchases of securities. However, monetary policy will remain very easy over the intermediate-term.

Economic growth in the European Union has been robust over the past several months, with output expected to return to pre-pandemic levels by the end of 2021 (ahead of initial projections).

Japan’s current Prime Minister, Yoshihide Suga, is stepping down after one term. The next Prime Minister is expected to come from the same party, the Liberal Democrats. Since Suga’s announcement, Japanese stocks have rallied sharply, about 6% in the last week alone, to 31-year highs.

Fixed Income Takeaways:

This week saw two very strong auctions in the Treasury market. Despite this fact, longer-dated Treasury yields drifted higher Friday morning, with the 10-year note trading at 1.32%.

Low yields and tight spreads continue to drive new issuance in the corporate bond markets. Within the investment-grade (IG) corporate credit market, about $77 billion of deals were priced this week. Activity has picked back up after slowing down before the Labor Day holiday.

Corporate bond funds continue to see strong inflows. Despite low absolute yields, the demand for both IG and high-yield paper remains robust.

The municipal bond market remained quiet this week, with about $6B of new deals pricing. Next week looks strong, with about $11B of deals expected to price. Spreads remain stable, and municipals remain expensive relative to Treasuries.

As with corporate bonds, money continues to pour into municipal bond funds at a torrid pace. This year has seen the strongest rate of inflows since the data has been collected (beginning in 1992).

It appears likely that an infrastructure bill will make its way through Congress over the next month. A $1 trillion bill has passed the Senate with bipartisan backing and will be voted on in the House by September 27th. A larger, $3.5 trillion bill has little Republican support and is also working through Congress.

General Takeaways:

First, our thoughts go out to the people in Hurricane Ida’s path.

The Afghanistan situation remains very tense, and we expect a challenging week ahead as the US prepares for final troop withdrawal. In addition, North Korea seems to have restarted its nuclear program.

The congressional calendar in September is jam-packed. Congress will continue to work on the current infrastructure bill. In addition, the debt ceiling limit deadline is September 30 / October 1. Federal Reserve (Fed) Chairman Jerome Powell’s term ends in 2022 – he is currently the odds-on choice for renomination in late 2021.

The Federal Reserve held its annual Jackson Hole Economic Symposium virtually last week. Key point: there is a specific difference between asset purchase tapering and tightening policy via interest rate hikes. See below for details.

COVID-19 update: cases, hospitalization, and fatalities are all rising, but at a decelerating rate, giving us some hope that the Delta outbreak may be peaking in the US. In response to increasing cases, the European Union is set to recommend halting nonessential travel from the United States.

The core private real estate asset class is having a strong 2021. Declining cap rates provided support for overall total returns. The impact of declining interest rates cannot be understated. As interest rates remain low, investors are looking to real estate for yield.

Demand for industrial properties remains extremely strong, with prices rising about 9% in the second quarter alone. The apartment sector also remains strong, with suburban multi-family properties outperforming urban high-rise properties as tenants seek more space.

Within office buildings, vacancies remain elevated, but pockets of opportunity depend on specific asset types. Weakness in the office sector is not a good reason to avoid private core real estate entirely.

Equity Takeaways:

Stocks were mixed in early Monday trading. The S&P 500 rose about 0.3%, while small caps dropped about 0.3%.

On Friday, asset prices rose after Fed Chairman Powell’s dovish comments, led by more economically sensitive cyclical sectors. For example, small caps rose almost 3% on Friday, while large caps rose about 0.9%. Bond prices also rose slightly on Friday.

Stock market performance in August has been strong. As of the market close on Friday, August 27, we are on track for a third consecutive 2%+ monthly gain. This type of price action is unusually strong for the summer months.

In the past, strong summer performance has portended strong future equity performance. 1995, 2013, and 2017 are the three most recent years that match the pattern we’ve seen year-to-date in 2021.

That said, September is usually the worst month of the year for the S&P 500, so some choppiness would not surprise us. Our main thesis remains unchanged – we expect the cyclical reflation trade to reassert itself in the fourth quarter.

Our preference remains with quality assets amidst declining breadth and a possible “fiscal cliff” of declining growth in federal stimulus. While on balance, we remain constructive on equities relative to bonds, some near-term caution is likely warranted.

Fixed Income Takeaways:

The market reaction to the Fed’s comments from last week was muted. Indeed, while the tapering of asset purchases in 2021 was expected, Chairman Powell did a good job of decoupling tapering from future rate hikes, saying that the criteria for future rate hikes are “more stringent” than tapering.

Powell’s speech met market expectations. Powell did acknowledge that tapering is likely in 2021 but did not give an explicit timeline. Market expectations are for an initial taper of asset purchases in November.

Powell’s speech contained four significant components:

1. Tapering;
2. COVID-19 Delta;
3. Rate Hikes; and
4. Economic Outlook.

He noted that the Fed’s “substantial further progress” test had been met with respect to inflation. Powell is cautiously optimistic on continued progress towards maximum employment.

In a pushback against the more hawkish committee members, Powell gave five reasons why inflation is likely to prove transitory over the long term. After the speech, market participants are pricing an initial rate hike in 2023.

The yield curve steepened slightly last week, bucking the trend of flattening going back to July. The 10-year Treasury yield was 1.30% in early trading on Monday and has traded in a tight range over the past several weeks.

High-yield bond spreads tightened sharply last week, with yields on the index dropping 22 basis points (bps) on the week. Overall, the search for yield continues, and the high-yield index is again trading below 4%.

We expect limited new issuance in the corporate bond markets this week due to next Monday’s Labor Day holiday.

General Takeaways:

COVID-19 cases (7-day average) have increased about 6% in the past seven days. The rate of change of growth continues to decrease, which is a positive sign that we may be approaching a peak in the infection rate in the United States.

On August 23, the Food and Drug Administration (FDA) officially approved the Pfizer-BioNTech COVID-19 vaccine in individuals 16 years of age and older. The name of this vaccine is “Comirnaty.” Now that this vaccine is officially approved, more companies are requiring enhanced vaccine protocols for employees.

The Federal Reserve’s (virtual) 2021 Jackson Hole Economic Policy Symposium begins today. Federal Reserve (Fed) Chairman Jerome Powell’s comments begin at 10:00 a.m. ET and will be closely parsed by market participants throughout the world.

Economic update: on balance, the economic data released in the United States this week remained positive, but the overall strength of the data has decreased, suggesting that peak growth rates may have occurred earlier in 2021.

For example, IHS Markit Composite PMI data declined to 55.4 in August, an eight-month low, down from 59.9 in July. Recall that Purchasing Manager Index readings above 50.0 indicate expansion.

A continued common theme in this data – both labor supply issues and supply chain bottlenecks persist across regions, and on balance, local business conditions seemed to deteriorate slightly in August.

This week, the Supreme Court blocked the existing federal ban on evictions instituted by the Biden administration. The court ruling stated that the Centers for Disease Control and Prevention (CDC) exceeded their authority with the ban and that landlords have been at risk of being harmed. Final steps or ensuing litigation are still to be determined.

New Homes for Sale (as a percentage of completed homes) are a good measure of the demand and supply balance in the housing market. Before the pandemic, this number was about 22%. Currently, this number has dropped to about 10%, indicating strong demand for houses – prices will likely remain firm as a result.

Equity Takeaways:

Stocks rose slightly in early trading on Friday as the market anticipated Federal Reserve Chairman Powell’s 10 a.m. ET comments. The S&P 500 rose about 0.3%, with small caps up 1%. International shares also rose slightly.

The market has continued to grind higher in the face of rising geopolitical turmoil. Indeed, the S&P 500 set a new all-time high on Wednesday before pulling back a bit on Thursday.

Breadth continues to be mixed. At the margin, S&P 500 breadth has improved slightly over the past few weeks, but the market generally remains without clear leadership. Since Memorial Day, defensive sectors have been the strongest on a relative basis. However, cyclicals have shown some strength over the past few weeks.

Key Private Bank continues to expect that cyclical sectors will re-assert leadership in the fourth quarter. One example of an improving cyclical sector is homebuilders, which have improved recently and are closing on a new relative strength high compared to the S&P 500.

According to the American Association of Individual Investors (AAII) survey, bullish sentiment has decreased over the past few weeks, a contrarian positive signal. Markets tend to climb a wall of worry.

One risk to the outlook would be a quick rise in interest rates. If rates rise faster than expected, the stock market will face a significant headwind.

China is seeking to create “common prosperity” while becoming self-sufficient on the world stage. Efforts in data security will likely continue, and the winners of the past may not be the winners of the future.

China’s COVID-19 cases are likely largely understated, although travel data from China’s upcoming “Golden Week” vacation may afford us some clues on the status of the current outbreak.

Fixed Income Takeaways:

Several Fed governors spoke this week in advance of Fed Chairman Powell’s Friday comments. Regardless of the actual start date, the Fed’s asset purchase tapering process is likely to be separate and distinct from any future decision to increase the Fed Funds rate.

On Friday, we expect that Powell will repeat his comments on transitory inflation, while noting the impact of the Delta variant on the economy. No official announcement on tapering is expected this week.

Within the corporate bond markets, new issuance was light this week. Activity is expected to increase sharply in September. Despite slightly widening spreads, investment-grade (IG) mutual funds have shown strongly positive flows over the past several weeks. High-yield fund data is mixed, with funds recently showing outflows amidst weakness in the lowest-rated credits.

Municipal bond fund flows remain very strong. Municipal bonds remain very expensive, especially on the front end of the curve.

General Takeaways:

President Biden’s approval rating continues to drop, with the tense situation in Afghanistan weighing on sentiment. According to Politico, in April 2021, 84% of Democrats, 66% of Independents, and 52% of Republicans supported a full withdrawal of US troops from Afghanistan. After recent events, those numbers have dropped to 69%, 41%, and 31% respectively. In April, 69% of all voters supported a full withdrawal – that number has dropped to 49% recently.

COVID-19 update: Despite high vaccination rates in Israel (over 70% of the population covered), the case count in Israel has begun to rise again, highlighting the increased transmission rate of the new virus variants.

The most significant economic impact of COVID-19 is generally associated with increased lockdown activity, which we see in different parts of the world (Australia, New Zealand, Vietnam, etc.). Within the United States, over the last month, survey data indicates that consumers are once again becoming more hesitant about various public activities (returning to the office, dining in a restaurant, going to a movie, etc.).

The Federal Reserve (Fed) will hold its annual Jackson Hole conference this week. The Fed is likely to lift its long-term interest rate forecast but lower its growth forecast. Tapering of asset purchases is likely to occur well before interest rate hikes. The current market consensus appears to be for the initial rate hike to happen sometime in 2023. We believe this forecast may be pulled forward slightly into late 2022 if the economy continues to improve.

Things to watch:

1. Inflation expectations
2. The shape of the US Treasury yield curve
3. Credit spreads
4. Currency movements
5. The future leadership of the Fed (Treasury Secretary Janet Yellen recently endorsed Jerome Powell for another term as Fed Chairman)

Equity Takeaways:

Stocks rose in early trading on Monday. The S&P 500 rose about 0.6%, with small caps up 0.9%. International shares also rose.

We’ve noted mixed breadth in the market over the past several months. Last Friday was a strong day, with over 80% of equities rising, albeit on light volume.

Indeed, last Friday was the slowest trading day on Key Private Bank’s equity trading desk all year. We expect activity should pick up moderately towards the end of this week (due to the critical Fed meeting).

It’s hard to be overly bearish on equities when both the US leading indicators (LEI) and corporate profits are both showing continued strength. Combined with low interest rates, these earnings have fortified corporate and consumer balance sheets, providing a strong backdrop for equities.

News out of China continues to drive Chinese technology shares lower. This increasingly broad crackdown does not appear likely to end anytime soon. Out of Europe and the UK, recent Purchasing Manager Index (PMI) data has been mixed.

Bitcoin and Ethereum have performed strongly over the past few weeks after significant drawdowns in May. The demand for Non-Fungible-Tokens (NFTs) provides a structural bid in the market for Ethereum, as most NFTs are tied to Ethereum’s platform.

Fixed Income Takeaways:

10-year Treasury yields fell 4 basis points last week, to 1.23%. Yields are reversing slightly higher this morning, with the 10-year Treasury trading at 1.27% early on Monday.

Market participants will be keenly focused on the speeches from this week’s Fed Jackson Hole symposium. Most market participants are not expecting an official announcement on the tapering of Fed asset purchases this week.

Based on the July Fed minutes, broad expectations are that the Federal Reserve will begin tapering asset purchases in November 2021, with an official announcement at the September meeting. As we’ve noted in the past, any future decision to raise interest rates will be independent of the decision to taper asset purchases.

An earlier start to tapering could result in a longer overall tapering period, giving the Fed more flexibility during the process. The Fed is likely to reduce purchases of both treasuries and mortgage-backed securities on a proportionate basis.

Corporate bond spreads (both investment-grade and high-yield) continued to drift wider last week in orderly trading. This week’s new issue supply calendar is fairly light, although overall issuance in August was robust compared to a typical August. Corporate bond supply is expected to increase once again in September.

General Takeaways:

COVID-19 Update: Cases in the US (7-day average) have increased 13% over the past seven days, compared to 18% the prior week. Vaccination rates continue to stagnate at about 500,000 / day. About 60% of the US population has received at least one vaccine dose, with 51% fully vaccinated.

With companies and organizations in certain industries (airlines, health care, etc.) requiring full vaccination to return to work, a lack of fully vaccinated workers could pressure the labor market in these affected sectors.

Key Points from July Federal Reserve (Fed) meeting minutes:

1. Growing sentiment to begin tapering sooner than previously forecasted
2. Desire to time future rate increases with strengthening economy
3. Risks of an inflation “overshoot” appear to outweigh the risks of an inflation “undershoot”
4. The labor market has not yet fully recovered
5. Future tapering will be evenly split between treasuries and mortgage-backed securities

The critical commentary in the July Fed minutes – effectively states that rate hikes will not automatically occur after asset purchase tapering is complete – rate hikes will only happen if the economy continues to improve:

“Many participants saw potential benefits in a pace of tapering that would end net asset purchases before the conditions currently specified in the Committee's forward guidance on the federal funds rate were likely to be met. At the same time, participants indicated that the standards for raising the target range for the federal funds rate were distinct from those associated with tapering asset purchases and remarked that the timing of those actions would depend on the course of the economy….”

Economic Data – Recap for the week:

July Retail Sales fell 1.1% from June. The year-over-year increase in retail sales (July 2020 to July 2021) was 15.8%. This data was weaker than expected and caused some volatility in the stock market early in the week. Empire State Manufacturing PMI also declined but remained in expansionary territory.

Bottom line: US economic data was generally positive during the week, but the rate of improvement in some of the data is slowing. “Peak growth” may have occurred earlier this year, and recent stock market choppiness may be somewhat related to this midcycle transition phase in the economy.

In the United Kingdom, inflation slowed unexpectedly in July, towards the Bank of England’s long-term 2% target. Market participants had been expecting about 3% inflation in the UK.

Since Brexit, the relationship of the UK with the Eurozone has deteriorated. As a result, London financiers are looking towards Southeast Asia as a source of future growth.

Equity Takeaways:

Equity futures were lower overnight but recovered in early Friday trading, with the S&P 500 rising about 0.5%. The Nasdaq rose 0.7%, and small caps were up about 0.2%.

Before trading opened Friday, the S&P was down about 1.7% during the week, on track for its worst weekly performance since June. The last time the S&P 500 had a correction of 5% or greater was October 2020.

This week, the stock market has been a bit choppy but did not react violently to news that the Federal Reserve (Fed) is contemplating tapering asset purchases sooner than expected.

Breadth in the S&P 500 remains soft. Only 55% of S&P 500 constituents are trading above their 50-day moving averages (slightly higher over the past few weeks, but still a fairly weak reading). Nasdaq breadth is even worse, with only 23% of its components trading above their 50-day moving averages.

Despite these near-term concerns, corporate earnings remain very strong. It will be difficult for the stock market to experience a significant correction in the current earnings environment. We believe that the next several months will be choppy, but equities should perform well in the fourth quarter.

Fixed Income Takeaways:

Yields on the 10-year Treasury note have fallen slightly this week, trading at 1.23% this morning on fears of slowing global growth. The 5-year / 30-year Treasury curve has flattened recently in anticipation of tighter Fed policy.

US treasuries remain attractive to foreign investors. Globally, there is about $16 trillion of debt with negative yields. The German 10-year note yields about -0.5%, for example.

Based on recent Fed comments, we anticipate that asset purchase tapering will likely begin in either November or December 2021. As noted above, tapering will be split between treasuries and mortgage-backed securities.

We expect that the official announcement of tapering should cause the yield curve to steepen, with longer-dated yields likely rising more than short-dated yields. Rate hikes still seem very unlikely before 2023.

Corporate bond spreads (investment-grade and high-yield) have drifted wider over the past few weeks, with the most significant widening occurring in the weakest credits. That said, the new issue market remains robust, as absolute yield levels remain very low, providing an attractive environment for corporate borrowers.

This week has been very quiet in the municipal bond market. Yields were essentially unchanged, and fund flows remain strong. Money continues to pour into municipal bonds. Positive fund flows have shown in 65 of the past 66 weeks.

Another factor supporting municipal bonds is low supply. The new deal volume in July 2021 was 25% lower than in July 2020. Secondary trading is very light.

General Takeaways:

There have been 213 trading days since the last correction of 5% or more in the S&P 500. This streak is the 9th longest in the previous 90 years.

While it’s true that September is the weakest seasonal month of the calendar year, it is followed by some of the best calendar months (November, December, and January).

What could go wrong in the coming months to derail the market?

1. Growth slowdown:

   Negative economic revisions for 2021 GDP growth are currently offset by positive economic revisions to the 2022 outlook.

2. Earnings Slowdown:

   The trend in earnings is similar – estimates for aggregate 2021 S&P 500 earnings have recently been revised fractionally lower, but the trend in 2022 remains higher.

3. Tax Hike:

   A corporate tax increase is being contemplated in Congress. The current 21% corporate tax rate could move higher as part of an additional stimulus package. Provided that the overall economic backdrop is solid, tax increases generally do not immediately result in a weaker stock market.

4. Federal Reserve (Fed) Policy Mistake:

   Fed asset purchase tapering versus tightening via rate hikes. The yield curve will give essential clues on whether the Fed policy is becoming too tight. The yield curve tends to flatten/invert during an economic slowdown.

5. COVID-19:

   Despite the recent Delta variant outbreak, the Goldman Sachs US reopening scale is up to 9/10 (with 10 being pre-pandemic levels of activity). As we noted on Friday, both cases and hospitalizations seem to have inflected lower in late August. New variants are the wild card.

   Old Wall Street saying: “Markets stop panicking when policymakers begin to panic.” President Biden’s recent speech on COVID-19 could mark the inflection point of the recent outbreak.

6. Inflation:

   After freight bottlenecks earlier in the year, containerships have begun to arrive at US ports but are now having trouble unloading. Supply shortages continue in certain sectors as a result.

   The “Misery Index” is the sum of Consumer Price Inflation and the Unemployment rate. Historically, a Misery Index above 10% has corresponded with slowing growth and high inflation (aka stagflation). The current level of the Misery Index is 10.5%, but this number would likely have to stay above 10% for quite some time for stagflation to take hold.

2021 is on pace for record global private capital fundraising. Various strategies continue to attract capital, such as private equity, venture capital, private debt, secondaries, real assets, and real estate. Private oil and gas strategies continue to lag in terms of performance. Manager selection remains paramount among all strategies.

Equity Takeaways:

On Monday, stocks were slightly higher in early trading, with the S&P 500 trading fractionally higher, while small caps rose about 0.5%.

The S&P 500 declined every day last week and now has a five-day losing streak for the first time since 2/16/21-2/22/21, and for only the second time all year. The last longer streak happened from 2/20/20-2/28/20 (seven trading days). In addition, the S&P 500 endured its first weekly decline of at least -1% since the week ending 6/18/2021.

After a -1% weekly loss since the March 2020 lows, the Index has been higher the following week 11/14 times (79% hit rate), with an average gain of +3.2%. Additionally, there were consecutive weekly losses of at least -1% only once over that time frame (the weeks ending 9/4/20 and 9/11/20). More recently, in 2021, the S&P 500 has logged gains the next week 4/5 times (80% hit rate), with an average move of +1.9%. This suggests an upside bias this week.

Markets climb a wall of worry. Over the summer, we had a stealth correction underneath the market's surface, with the average stock declining over 7%.

Weekly S&P 500 breadth dropped to 84% negative (meaning 84% of SPX issues were negative for the week), one of the worst weekly internal readings all year. The index had negative daily numbers each of last week’s four days, with the S&P 500 Index’s cumulative advance/decline line now noticeably below the early September highs. We have highlighted bad breadth in our commentary since the end of July.

Key Private Bank continues to expect a strong finish to the year in the equity markets, supported by strong earnings. However, we continue to believe that the market could be choppy over the next 3-4 weeks. Seasonal patterns will begin to turn favorably in mid-October.

Fixed Income Takeaways:

The 10-year Treasury note continues to trade in a range, showing a 1.32% yield as/of Monday morning. The yield curve continues to flatten slightly due to declining yields on the long end.

After the Labor Day holiday, investment-grade (IG) corporate bond spreads tightened slightly despite heavy supply. Fifty-four issuers came to market last week, eclipsing the weekly record of 52 issuers. Money continues to pour into corporate bond funds to support this new issuance.

High-yield corporate bonds also had a strong week. Year-to-date (YTD), high-yield spreads are about 75 basis points tighter.

Talks of a delayed debt ceiling extension put some pressure on short-term money market instruments, including Treasury bills. The government’s ability to borrow in the Treasury bill market will be severely limited as we move through October without an updated debt ceiling.

Later this week, important inflation data will be released. Core Consumer Price Index (CPI) data will be released Tuesday. The Federal Reserve will be watching any incremental economic data very closely to inform their decision on tapering.

General Takeaways:

Economic news released this week continued to provide an upbeat tone; overall, although certain areas indicated mild reservations.

For the month-ending in June: job openings are up to a high of just over 10 million; new hires exceeded separations (known as the net change in employment) by 1.1 million, while layoffs remained the same as last month at a series low.

Labor productivity continues to rise, and the second quarter of 2021 is the fourth consecutive quarter with increases in output and hours worked, following historic declines a year ago. The index is now 1.2% above the level seen in the fourth quarter of 2019, the last quarter not affected by the COVID-19 pandemic. Initial and ongoing unemployment claims continue to trend favorably, although 4-week averages for both remained consistent with the prior week.

According to the Conference Board, consumer confidence continues to be strong. We expect overall estimated consumer net worth for 3rd quarter of 2021 to reach record levels.

However, within the midst of economic improvement, small businesses continue to experience labor challenges. According to the NFIB Small Business Optimism Index, which decreased in July, 49% of owners reported job openings that could not be filled, a 48-year record high.

The next few months will be critical in the inter-relationship between job openings, hiring challenges, unemployment, and economic growth. In the US, an estimated 7.5 million individuals will no longer receive unemployment benefits after Labor Day. Three federal unemployment aid programs put in place to address the pandemic will end next month. We are closely watching the direction of the response – will individuals return to the labor force as a result, or will other factors, including the Delta variant, keep workers on the sidelines? If the labor market takes longer to rebound, consumer spending and GDP may come in weaker than anticipated.

This week’s inflation print showed the Consumer Price Index (CPI) for July remains elevated but was lower than June on a month-over-month basis (0.5% increase in July versus 0.9% increase in June) and represented the lowest reading in four months. Core CPI also showed signs of moderating (0.3% increase in July versus 0.9% increase in June). The Producer Price Index (PPI) for July showed a 12-month increase of 7.8% – higher than June and the largest since November 2010. Next month’s report will be critical in determining to what degree inflation has been transitory versus permanent, given the base effect from the prior 12 months will become much less relevant.

COVID cases in the US have increased over 18% in the past week (7-day moving average), somewhat slowing relative to the prior week’s increase of approximately 36%. The 7-day average neared 113,000 versus 95,000 last week and 20,000 in June. Vaccinations continue to stall.

Equity Takeaways:

US equities opened flat this morning, with all three major indices remaining relatively unchanged (DJIA, S&P 500, and Nasdaq). Small caps declined 0.5%.

During the past week, many of the prior new highs occurred at the market open and then faded off during the trading session; but yesterday, new highs carried through the day and into the afternoon. These highs represent a continued positive flow into purchasing of stocks.

The market continues to grind higher. Consistent with forward earnings estimates for later in 2021 and into 2022, the S&P 500 is heading toward the 4500 level and is likely to be higher by year-end.

Large-cap growth shares were back in the driver’s seat yesterday, although we see improvement in cyclicals, notably financials.

As we head into the middle of the month, commodities are starting to make a comeback from previous highs earlier in the year, followed by more recent declines in the summer.

This trend is foundational to our Key Private Bank thesis for equity markets. We have seen the summer doldrums as a mid-cycle transition and are looking for cyclical re-acceleration in the second half of the year.

Japan markets have lagged this year as a result of COVID cases and a state of emergency. Yet, there may be a light at the end of the tunnel concerning surging corporate earnings for the second half of the year. And the state of emergency might lead to additional stimulus later this year. Vaccinations have increased from 5% of the population having one dose as late as May to over 60%. Japan has not had a reopening ‘bump’ yet and may be poised to do so later this year.

China continues the crackdown on certain industries as it plays a role in its 5-year plan. FinTech, Education, Celebrities & Influencers industries will be most affected. Reasons behind the efforts include:

1. Battling of inequality of opportunity,
2. Development and incubation of their capital markets by restricting overseas winners, and
3. Geopolitics and reducing Western dependencies – notably oil, microchips, and the US dollar.

Environmental initiatives, including EV and renewable energy research, can lead to self-sufficiency in the resource-poor country, as could a reliable chip infrastructure. As Chinese capital markets become deeper and more liquid, Beijing might entice trade partners to begin transacting in Yuan instead of USD. These areas may lead to potential investment opportunities. Winners moving forward may not look the same as the global tech darlings that led market performance over the past few years.

Fixed Income Takeaways:

Fixed income markets are also focused on inflation data, with the Treasury curve supporting Federal Reserve (Fed) Chair Jerome Powell’s commentary on inflation being more transitory. That being said, inflation is rising at a pace well above the moderate overshoot from the Fed’s 2% target.

The 10-year Treasury auction this week was very strong, with the yield currently at 1.35%. We have seen a rise in yields over the past two weeks but have stabilized at around 1.30% to 1.35%.

Investment grade (IG) credit spreads were tighter by 1 basis point, the first tightening after 11 trading sessions. Some weakening in credit did occur but was orderly. We have been in the range of 85 to 88 basis points for the past few weeks. High yield spreads were 2 basis points tighter yesterday.

Junk bonds are set to post negative returns for the second straight week. CCC-rated bonds are on track to post negative returns for the sixth consecutive week and are yielding around 6.35%. A few months ago, the yields dipped below 6%.

This week's expectations for IG new issuance were at levels of approximately $30 billion, and issuance exceeded that by Wednesday of the week, totaling $35 billion. So far in August, new issuance has totaled over $73 billion, on target to exceed the consensus expectation of $80 billion for the full month. With that being said, we sense some investor fatigue creeping into the market. There have been so many deals and not many concessions; investors are being more selective in deals, and we may see a slowdown heading into Labor Day.

IG fund inflows increased this week at a level of $3.9 billion, reversing last week’s outflows of $400 million. High Yield fund inflows increased this week at a level of $510 million, reversing last week’s outflows of $1.5 billion.

Money continues to pour into Municipal bond funds at about $2 billion for the week, even as nominal yields continue to be low and ratios relative to Treasuries continue to be low. Net inflows have occurred in the past 64 out of 65 weeks, on pace to break the record for calendar year inflows.

We are keeping an eye on the long end (20-30 year) of the muni market, where poor liquidity has led to yields ticking higher. We anticipate some moderate improvement in the next few weeks.

General Takeaways:

What did we learn from Friday’s employment report? The jobs data was strong across the board: the unemployment rate plunged to 5.4%; household employment surged +1.0 million month-over-month in July; payroll employment (with revisions) increased +1.1 million; average hourly earnings rose +0.4% month-over-month, which equates to a +4.4% annual rate; and, labor force participation expanded with all demographic cohorts improving and the median duration of unemployment declining.

Let’s remember that FOMC Chair Powell is looking for a “string” of strong readings to meet the definition of “substantial further improvement” in the labor market. Once achieved, tapering of QE asset prices will likely commence. Friday’s employment report suggests we’re getting closer to this happening.

Is inflation picking up or rolling over? Remember when the prices of used cars were substantially on the rise? Higher prices may have been “cured” by higher prices as the recent trend shows vehicle sales in July have declined.

But higher prices can persist until they become problematic. Moreover, higher wages and rents are typically more persistent, and inflation seems to be picking up. Growth in average hourly wages is the strongest in nearly 40 years and rising – and this dynamic has a trickle effect that can promote higher spending and thus higher broader inflation in the overall economy. Furthermore, unemployment falling while job openings are rising is likely to lead to higher wages.

While we’d never build an investment thesis around one day (especially on a Friday in the middle of summer), Friday’s employment report may have convinced the market that concerns over the second derivative (i.e., the growth rate of the growth rate slowing) may be overstated. Instead, the market should be refocusing its attention on inflation. As evidence, cyclicals outperformed defensives, value stocks outpaced growth shares, and bond prices declined. These are all trends worth watching.

COVID cases and hospitalizations continue to be on the rise. However, there is potential for a “silver lining” as trends in cases in the UK peaked and are on the decline in a relatively short period.

We are watching for trends in US cases to potentially spike or peak by Labor Day, as this time is not only crucial for back-to-school events but even more critical for implications for the employment situation. The next few weeks are likely to be more volatile in terms of reporting.

According to Bloomberg, vaccinations in the US are up at almost 200,000 per day from one month ago but well below peak levels in April; roughly 55% of Americans are now fully covered.

Equity Takeaways:

Despite the strong employment report from Friday, US equities opened mixed this morning. The S&P 500 declined marginally by 0.2%, while the Nasdaq rose 0.1%. Small caps were down 0.6%.

The second-quarter earnings season has been as strong as it needed to be. Overall, 89% percent of the S&P 500 had reported second-quarter results, with 87% of these companies beating Wall Street estimates, a record back to 2008 when FactSet first started tracking this data. The old record was the first quarter of 2021 (when 86% of companies beat).

The second quarter’s average earnings beat was 17.1 percentage points, the 4th best-ever back to 2008. The record was back in the second quarter of 2020 when analysts first started the recent trend of meaningfully underestimating US corporate earnings power. The average revenue beat in the second quarter was 4.9 points, also a record.

From our perspective, the most impressive data point is seeing 17 points of earnings beats on 5 points of revenue beats. This trend speaks to the power of US corporate earnings leverage and companies’ ability to generate incremental cash flow from marginal revenue gains. Whether this earnings leverage can continue could be critical for equities in the future.

Historically, we have noticed that when the market experiences a strong move upward in rates, small-cap, cyclical, and value stocks often perform well (and the opposite also appears to occur).

Fixed Income Takeaways:

Last week, Dallas Fed president Kaplan provided commentary regarding a gradual, balanced bond tapering coming soon, pushing yields higher across the curve. The outlook included the potential for tapering of bond purchases to be complete within eight months. Reductions in bond purchases would consist of both Treasuries and Mortgages at the same time in some balanced ratio.

Fed Vice Chair Clarida also provided some interesting comments, consistent with Chair Powell. His outlook could support a tapering announcement later this year as well.

The 10-year Treasury yield ended last week at 1.30%, 17 basis points higher than its intra-week low. We are watching yields this week as inflation data will be reported (CPI and PPI).

Investment grade (IG) credit spreads ended Friday unchanged and were 1 basis point wider on the week. High yield spreads were 3 basis points tighter on Friday and 2 basis points wider on the week.

As earnings continue, issuers are posting strong growth for the quarter; but the threat of rising rates together with strong supply has pushed wider than we have seen in the past month. IG supply issuance remains favorable and will likely be busier in the first part of this week before the inflation data is released.

This week's expectations for IG new issuance are at levels of approximately $25-$30 billion, similar to last week’s $32 billion in volume. This is the second week in a row we have seen volume exceed the forecast as issuers take advantage of where rates have been.

General Takeaways:

Purchasing Manager Index (PMI) data showed continued expansionary trends in the economy's manufacturing and service sectors in July. This data is confirmed by continued strength in Evercore ISI’s trucking company sales surveys. Trucking company data has a 76% correlation with industrial production.

The labor market continues to improve. Non-farm payrolls increased by 943K in July, above the consensus of 845K, after revised gains of 938K in June and 583K in May. The unemployment rate dropped to 5.4% from 5.9%.

The labor force participation rate ticked slightly higher, to 61.7%, indicating that some displaced workers are returning to the labor market. That said, labor force participation is still considerably below pre-pandemic levels.

The Federal Reserve (Fed) will continue to watch this labor market data closely before making a move to tighten policy. The Fed is looking for both a continued decrease in the unemployment rate and an increase in the labor force participation rate as precursors to tighter monetary policy.

COVID-19 update – new cases have increased about fivefold since June. Over the last six weeks, the 7-day average of new daily cases has risen to almost 90,000, from less than 20,000.

As workers return to the office, occupancy in urban markets appears to be increasing. Survey data showed a sharp increase in apartment rents over the past several months.

Equity Takeaways:

Despite the strong employment report, US equities opened mixed this morning. The S&P 500 rose about 0.1%, while the Nasdaq dropped 0.3%. Small caps rose 0.6%.

Market participants are seemingly worried that the strong economic report could cause the Fed to tighten policy sooner than expected. Also, as we’ve discussed in the past, August tends to be a weak seasonal period for the stock market.

Across the S&P 500, breadth has improved over the past few weeks. About 56% of S&P 500 constituents are trading above their 50-day moving averages. The story is different in the tech-heavy Nasdaq, where just over 30% of constituents are trading above their 50-day moving averages. This level of weakness in breadth is unusual for the Nasdaq, occurring only about 12% of the time and could result in some short-term volatility.

European equities have had a nice week, with several all-time highs being set. STOXX 600 earnings estimates continue to improve and are now expected to increase 140% year-over-year (the STOXX 600 is a broad index of large cap European stocks). The European composite PMI was 60.6 last month, it's strongest reading in at least 21 years.

Within the UK, the COVID-19 Delta variant seems to have run its course. About 70% of the UK population is vaccinated. Economic data within the UK is showing solid strength as the economy reopens. This strong data has caused the Bank of England (BoE) to become a bit more hawkish. Within developed nations, the BoE looks likely to be the first to reduce monetary accommodation.

Fixed Income Takeaways:

The 10-year Treasury yield jumped 6 basis points (bps), to 1.29%, after Friday morning’s strong employment report. The 10-year yield hit a low of 1.12% in July. Bond market participants are likely worried that the Fed may be forced to remove stimulus sooner rather than later due to strong economic data (and possible inflation from a tightening labor market).

Next week, we expect a very busy Monday in the new investment-grade (IG) bond market. Last week, both IG and high-yield corporate bond funds experienced outflows. Over the short term, issuers may be in a hurry to bring new deals to market if rates continue to rise.

Spreads on lower-quality corporates are beginning to drift wider relative to higher-quality corporates. For example, the spread between single-B corporate bonds and double-B corporate bonds widened during the week.

Conversely, municipal bond funds continued to see substantial inflows last week. Money is pouring into the asset class, with positive net flows in 61 of the past 62 weeks, especially on the front-end of the curve.

Municipal bond yields were very stable despite volatility in the Treasury bond market and generally remain very expensive relative to Treasuries. This week, Treasury bond yields moved higher, while municipal yields dropped several basis points.

General Takeaways:

Large cap US growth stocks outperformed most other classes of equity in July, rising 3.3%, while small caps lagged, with small cap growth and small cap value stocks each falling by 3.6% during the month.

On a year-to-date basis, large cap US stocks have risen about 18%, small caps have risen 13.3%, non-US developed stocks have risen 8.1%, and emerging market equities have dropped slightly. The US continues to lead.

Recent equity underperformance in China has in part been caused by the Chinese government’s crackdown on large technology companies. China is a state capitalist system, and in such a system, the people's interests are often put in front of corporate profits.

Overall, emerging market equities fell 7% in July, led by weakness in China. After this weakness, Chinese equities are pricing in modest future growth expectations compared to their US counterparts – in other words, Chinese stocks are cheaper than US stocks on some metrics. Key Private Bank continues to recommend an allocation to emerging market equities to provide growth and enhance diversification within equity portfolios.

Measuring cases per 1M people, the trajectory of the COVID-19 Delta variant outbreak in Southwest Missouri bears a striking resemblance to the outbreak in the UK. Both outbreaks showed signs of peaking after about nine weeks. It is also worth noting that the Delta outbreak in India has also significantly slowed since peaking several months ago.

To summarize last week’s economic reports – the COVID recession has ended. As noted on Friday, the Employment Cost Index (ECI) showed a solid 2.8% gain, but this measure of wage growth was surprisingly below expectations. The highlight of this week will be Friday’s non-farm payroll report.

Cryptocurrency Update: Bitcoin and Ethereum have both had substantial price rallies over the past few weeks. Simultaneously, various financial service companies have announced expanded crypto initiatives, and several large tech companies appear poised to expand adoption. A tremendous amount of capital is being deployed into the crypto space, which will likely result in continued innovation across various industries.

Equity Takeaways:

Stocks rose in early trading on Monday. The S&P 500 rose about 0.3%, with small caps up about 1.4%. International shares rose almost 1%.

The second quarter of the 2021 earnings season is wrapping up, and it was a very strong one. With 59% of S&P 500 companies having reported, 88% have beaten expectations. As a result, forward analyst estimates have continued to rise, which should continue to support stock prices. We believe that earnings estimates will continue to rise as we move through 2021.

That said, due to strong recent stock market performance, the market is a bit expensive based on historical Price/Earnings ratios. Earnings will need to continue to rise, and Price/Earnings multiples will need to remain stable or continue to expand to continue the rally.

Key Private Bank continues to expect that the next 6-8 weeks could be choppy as the stock market digests recent gains. After this period of possible turbulence, we expect a strong fourth quarter of 2021 and ultimately a higher stock market one year from now. A recent Key Questions article discusses our equity outlook in more detail.

Companies continue to discuss supply chain pressures. Some costs are being passed through to consumers, but companies are being forced to absorb some costs themselves. For example, the global container shipping market remains very tight, and we expect this situation to persist into late 2022.

Fixed Income Takeaways:

Treasury yields are slightly lower in early trading on Monday – the 10-year treasury note traded at 1.21%, about 3 basis points lower from Friday’s close.

This week is a light one for Federal Reserve speakers, which should help dampen volatility in the treasury market. That said, Vice Chairman Richard Clarida is speaking this week, and he tends to be one of the Federal Reserve’s more hawkish members.

New corporate bond deals continue to receive very strong execution. The seemingly insatiable demand for corporate bonds has allowed borrowers to issue paper at tight spreads to improve their balance sheets. Spreads continue to remain very stable even amidst this heavy supply.

Last week, the Federal Reserve announced a new, permanent standing repo facility. This tool will allow large primary dealers to exchange treasuries, agency debt, and agency-mortgage-backed securities for one-day loans. The tool is designed to ensure liquidity in the short-term funding system during periods of stress.

General Takeaways:

The economic data released during this week was once again generally positive. As reported in the Case-Shiller US Home Price Index, house prices increased another 2.1% in May and have increased 16.6% year-over-year on a national basis. Real GDP grew 6.5% in the second quarter.

Consumer confidence remains strong, unemployment claims have stabilized (but remain elevated relative to pre-pandemic levels), and several regional gauges of manufacturing output continue to indicate strength in the economy. Friday morning, data on Personal Income and Consumer Spending both exceeded expectations.

On the inflation front, on Friday, we also learned that the Core Personal Consumption Expenditures (PCE) Price Index rose 0.4% month/month and 3.5% year/year in June. Both increases were slightly below expectations. PCE inflation is one of the Federal Reserve’s favored measures of inflation.

Another important metric of inflation, the Employment Cost Index, was also reported Friday morning. This metric increased 0.7% quarter/quarter and 2.9% year/year. Economists were expecting a 0.9% rise in the quarter.

The Beveridge Curve indicates a skills mismatch between job openings and available jobs. In other words, job openings are plentiful, but there appears to be a shortage of workers with the necessary skills to fill many of them.

COVID-19 cases in the US have increased by almost 50% from the prior week. The 7-day moving average of daily cases has increased from about 40,000 one week ago to about 60,000 one week later. Hospitalizations have also increased while the rate of vaccination has stalled.

A bipartisan group of Senators struck an agreement on a roughly $1 trillion infrastructure bill on Wednesday, voting 67-32 to begin consideration of the bill. This bill contains approximately $550 billion of new federal spending.

Equity Takeaways:

Stocks were mixed in early trading on Friday. The S&P 500 fell about 0.25%, while the tech-heavy Nasdaq fell about 0.5%. International shares also fell slightly, while small caps rose about 0.5%.

About 75% of the S&P 500 has reported 2Q:2021 earnings. On average, companies have beaten analyst estimates by about 17%, with financials the largest outperformer. About 87% of companies have exceeded consensus earnings estimates.

The second quarter is resulting in more typical price action after earnings reports – companies that have exceeded estimates are being rewarded, while companies that have missed estimates are seeing their stock prices punished. During the earnings recovery after the COVID-induced recession, investors were mainly focused on the forward outlook rather than on reported earnings.

Fixed Income Takeaways:

The 10-year Treasury note yield has held firm in recent weeks and traded at 1.25% early Friday morning. If the 10-year Treasury closes at this level on Friday, it would be the fifth consecutive week of lower yields.

The investment-grade (IG) corporate bond new issue calendar ramped up this week. Deals continue to price into very high demand – spreads are tight. The pace of new issuance has slowed compared to last year but remains elevated relative to historic levels (2020 saw record levels of new issuance).

In this week’s Federal Reserve (Fed) meeting, Chairman Jerome Powell successfully took baby steps towards tapering (the reduction of Fed bond purchases) without sounding too hawkish.

Market participants are worried that the Fed might remove stimulus too soon. In this week’s meeting, Powell seemed to calm some of those fears. The Fed’s message indicated that economic progress is being made but that the Fed is in no rush to remove stimulus. Continued progress in the labor market remains a focal point for the Fed.

Powell also noted that the Fed is not even considering raising interest rates at this point. The initial reduction of stimulus will revolve around the tapering of Fed bond purchases.

Municipal bonds have seen positive inflows in 62 of the last 63 weeks. August is set to be a heavy month for municipal bond maturities, which will help maintain an elevated level of cash in the market that will need reinvestment. September, on the other hand, is a light month for maturities.

General Takeaways:

As we noted in last Friday’s comment, the National Bureau of Economic Research (NBER) dated last year’s recession as the shortest on record, beginning in February 2020 and ending just two months later.

During the ensuing economic recovery, the S&P 500 rose 48% between April 2020 and June 2021. These returns are among the strongest of any expansion in the last nine decades. Only the expansion that began in 1933 showed stronger initial returns.

Evercore ISI Company Surveys are booming. Retail sales momentum continues, and companies are reaping the benefits. This data is consistent with very strong corporate earnings (discussed below). However, inventories remain very low, which could cause future supply issues.

On Friday, the Employment Cost Index (ECI) will be reported. This number is an important inflation metric. Expectations are for a 5% increase, which would be the most significant increase for many years but not unprecedented.

COVID-19 update: cases in Israel are beginning to rise, even amongst the fully vaccinated. Thankfully, hospitalizations and fatalities have not increased significantly. A flare-up in cases in the Jiangsu province of China is also prompting some concern, as China’s approach to COVID has been “isolate and control” from the beginning.

Within the United States, COVID-19 cases and hospitalizations are on the rise, especially amongst the unvaccinated. First dose vaccine administrations are showing signs of bottoming after weeks of steady decline.

Credit spreads remain a critical indicator for the health of the overall market. They have remained primarily stable over the past few weeks despite the recent uptick in equity volatility – details below.

Equity Takeaways:

US large cap stocks were essentially flat in early trading on Monday, while small caps rose about 1%. International shares were generally lower, led by weakness in emerging market stocks.

The S&P 500 hit another all-time high last week. It has been 179 trading days since the last 5% drawdown in the S&P 500. Since 1929, the average period between 5% drawdowns has been 94 trading days.

24% of S&P 500 companies have reported 2Q:2021 earnings. On average, revenues are coming in 4% above expectations, a record going back to 2008. 86% of companies have beaten revenue expectations.

The S&P 500 appears poised for 20%+ aggregate earnings growth during the quarter. 88% of reporting companies have reported earnings above expectations, with the average beat 19% above analyst estimates.

Key Private Bank believes the equity market is currently in a mid-cycle transition phase. We expect a choppy market over the next few months. As bond yields have fallen over the past few months, growth stocks have reasserted market leadership. We expect this dynamic to continue throughout the third quarter of 2021.

In the fourth quarter, once the “summer doldrums” are complete, we expect the reflation trade to reassert itself. Cyclical sectors like financials, industrials, materials, and energy have lagged over the past several months – we believe these sectors will likely reassert leadership in the fourth quarter.

Earnings estimates for the rest of 2021 and 2022 are probably still too low, but expectations are high, so it is important that realized earnings continue to show strength. Based on where credit spreads and equity valuations are currently, we believe that equities still hold good relative value to bonds.

Market leadership (breadth) narrowed in 2Q:2021. When breadth narrows, active managers tend to have a tough time outperforming the indices.

Emerging markets will continue to be driven by the outlook in China. The Chinese government has been cracking down on any sector that appears to be “hot.” Recent examples include a crackdown on companies that provide online tutoring, as well as a recent hike in mortgage rates for first-time homebuyers.

Fixed Income Takeaways:

The 10-year Treasury yield was 1.29% in early trading on Monday, 1 basis point higher on the day.

Investment-grade (IG) credit spreads moved 8-12 basis points wider last Monday in conjunction with the selloff in equities but tightened throughout the rest of the week to close mainly unchanged on the week.

Last week was a light one for new IG corporate bond issuance, as many investors were likely spooked by last Monday’s volatility in credit spreads.

The Federal Reserve Open Market Committee (FOMC) is set to meet again this week. At this meeting, the Federal Reserve (Fed) is expected to further hint at the tapering of bond purchases, but no explicit updated guidance is likely to be given.

The Fed will not be releasing an updated set of economic projections after this meeting. This fact will likely allow Fed Chairman Jerome Powell to control the post-meeting messaging. Powell remains one of the more dovish members of the Committee.

Within actively managed fixed income funds, active managers tend to outperform the indices when credit spreads are tightening and vice versa. Credit spreads narrowed in the second quarter of 2021. Thus, most active managers showed strong relative performance during the quarter.

General Takeaways:

In last week’s Key Questions, Key Private Bank’s Chief Investment Officer, George Mateyo, discussed the National Bureau of Economic Research (NBER) and their method of dating recessions, noting that the NBER had yet to officially declare the end of the 2020 recession. This week, the NBER determined that the 2020 recession lasted two months from peak to trough (February 2020 to April 2020), making it the shortest recession on record.

The housing market remains robust. In June, housing starts increased 6% over May levels, driven by low mortgage rates. 30-year mortgage rates continue to hover near all-time lows, last checking in at 2.98% on average.

Lean inventories and supply chain constraints are creating strong demand for transportation – Evercore ISI Trucking Survey data confirms this trend. This trucking survey tends to correlate with US real GDP growth.

The Conference board is projecting year-over-year real GDP growth of 6.6% in 2021. The Leading Economic Index (LEI) rose 0.7% in June, after increases of 1.3% in April and 1.2% in May. Economic growth remains strong but appears to be slowing. As George Mateyo noted in the aforementioned Key Questions article, the economy seems to be transitioning from an early-cycle “V-shaped” recovery to a mid-cycle phase of more moderate growth.

Cryptocurrency items of note: the SEC said this month that it would seek public comment on WisdomTree’s proposal to launch a bitcoin ETF. The SEC is also looking at new regulations to help prevent fraud in the cryptocurrency markets. Several regulatory bodies are looking at updating the accounting rules surrounding cryptocurrencies held on corporate balance sheets.

Equity Takeaways:

US markets rose in early trading on Friday. The S&P 500 rose about 0.4%, while the Nasdaq rose about 0.25%. Small caps also rose about 0.25%.

The Nasdaq is currently trading at all-time highs, and the S&P 500 is once again approaching an all-time high. The recent dip in bond yields has provided support for technology stocks, which have resumed market leadership. Value stocks have significantly lagged growth stocks over the last several months.

This week, the focus in the market shifted from “peak growth” fears and concerns about the Delta COVID-19 variant back to earnings season, which is off to a strong start. After a sharp dip on Monday, stocks staged a solid snapback rally throughout the week.

Back in April, over 90% of S&P 500 stocks were above their 50-day moving averages. Currently, less than 50% of S&P 500 stocks are above their 50-day moving average. Breadth has been declining, and the largest stocks are supporting the averages.

Earnings season: 111 of 500 S&P companies have reported second-quarter numbers. 82% of companies have beaten revenue estimates, with 87% beating on the bottom line. In addition, commentary from management has been optimistic about the outlook, with few companies reporting a business impact from the Delta variant. In addition, profit margins remain robust, indicating that companies are passing their increased labor and material costs through to consumers.

A mean reversion pause for stocks could be driven by various factors, with the most likely being a slowdown in economic growth and corporate profits. Less likely scenarios include a more hawkish (less accommodative) Federal Reserve (Fed) or a return of disinflation/deflation.

The European Central Bank (ECB) made a few subtle changes to their long-term guidance, resulting in more accommodative policy for a longer period. The ECB stated that they would rather raise rates too late than too early (this is a change from their stance after the 2008 Great Financial Crisis).

Fixed Income Takeaways:

The 10-year Treasury rate was trading at 1.30% in early Friday trading, about 2 basis points higher on the day.

A combination of fundamental (slowing growth and stimulus) and technical factors has driven rates lower than expected in a short period of time. Likely, interest rates will once again begin to drift higher as we head through the remainder of 2021.

There is currently a dearth of single-A and higher-rated paper available in the corporate bond market. More and more issuers have taken on cheap debt, resulting in credit downgrades. About 51% of the investment-grade credit market is rated BBB. With debt costs so low, many companies have made the conscious decision to increase leverage.

The Fed is likely to begin removing monetary accommodation sometime in 2022. The market is expecting a formal announcement of asset purchase tapering in December 2021.

Over the past week, investment-grade (IG) corporate bond funds saw their first outflows in many weeks. All three major corporate bond asset classes (IG, high-yield, leveraged loans) each saw outflows – this is the first time all three saw outflows in the last 18 weeks.

Conversely, municipal bonds continue to see inflows and have seen positive flows in 61 of the last 62 weeks. The fundamental picture in the municipal bond market remains solid, with state revenue normalizing after the pandemic. However, municipal bonds are expensive relative to treasuries on virtually all historical metrics.

General Takeaways:

A few weeks ago, we listed several items to consider for the second half of the year; and it appears many are unfolding and worthy of continued monitoring:

1. Delta variant and continued vaccination challenges
2. Inflation pressures are building (energy, commodities, and wages = margin pressures and lower earnings)
3. Economic growth and fiscal support peaking (transition, not turmoil in our view)
4. Policy error: Fed miscommunication, tax policy, or regulatory over-reach
5. China slams on the brakes on their economy and their companies
6. Sentiment/Valuations, and some feelings of complacency
7. Something else we don’t know/aren’t thinking about

One week does not a trend make, but there may be some signals in last week’s stock market declines. Indicators favor a focus on quality as large cap stocks outperformed small cap stocks.

This quarter’s earnings season might need to be perfect. Last quarter, approximately 90% of companies that reported earnings exceeded expectations. For stocks to continue working in the near term, this trend may need to continue. Given the focus on inflation, the outlook for margins will be an essential data point to assess.

Stocks have historically paused after an earnings peak, but not a reason to panic. Cycles in 1993, 2004, and 2009 all experienced short-term declines in S&P500 market returns in the subsequent six months; however, returns were strong in the following 12-36 months.

There is a disconnect between current interest rates and inflation relative to other times in history. In past periods when inflation was higher than usual (US Core CPI near 4%), 10-year bond yields were in the 5-8% range. The 10-year Treasury yield is currently at 1.3%. This is an unusually abnormal period, and Fed policy regarding the pandemic economic recovery may need to reflect this environment carefully.

Credit spreads are at/near all-time lows, and there is an open question as to how long this might persist. Particularly in the Investment-grade (IG) space, spreads are at about 111 basis points above Treasuries, near an all-time low. High-yield spreads are also low at 314 basis points (bps) above Treasuries, levels not seen since 2007.

Some transitory inflation indicators might become more structural. Consumers’ mindsets are shifting relative to the demand for goods and services, and inflation expectations one year ahead are at 4.8%. Further out into the future, 3-year and 5-year expectations are still elevated at 3.5% and 2.9%, respectively, compared to the last five years.

The cure for higher prices is higher prices – and higher prices are causing demand destruction in certain areas as consumers protest mark-ups. The University of Michigan consumer surveys on a good time to buy a house or a car indicate both are down sharply. US house sales have stalled, despite record-low mortgage rates, because of surging prices. And now, with lumber production greater than lumber new orders, lumber prices are crashing, so perhaps the CPI surge will turn out to be transitory. We believe wages will be the key.

Optimism is generally evident within the economy, especially within small businesses. In addition, optimism is showing via the general public’s receptivity to re-engaging in everyday activities such as dining out, returning to work, staying at a hotel, and using public transportation.

Regarding the Delta variant and vaccination challenges, cases and hospitalizations are again rising in the US and globally. There is a disparity between states with lower fully vaccinated rates seeing a recent higher spike in new cases and those with higher fully vaccinated rates experiencing fewer new cases in the US.

The most concerning resurgence of COVID has been in the UK. This is because the UK is the second farthest along among developed countries in getting vaccinated. Despite this, infections in the UK have surged back close to January 2021 highs. Notwithstanding higher cases, fatalities remain low. Moreover, cases are rising more slowly in the age 70+ population group as arguably these individuals have been vaccinated at a higher rate relative to their younger peers.

Bottlenecks in construction supplies are creating longer lead times in real estate development. The industrial sector has had very high demand from several trends, including e-commerce, the need for data centers, and logistics hubs. Strong demand existed throughout the sector over recent years, and COVID accelerated it.

A 24% increase in materials and lead times have increased to 12-18 months to develop industrial buildings where it has historically been 8-10 months, leading to a tight market. This constrained supply in an environment of increasing demand has been bullish for commercial real estate. The existing buildings needing to keep up with replacement costs also provide a favorable backdrop.

Equity Takeaways:

Stocks fell in early trading on Monday. All three major indices declined, with the S&P 500, Dow Jones Industrial Average, and Nasdaq all being down about 1.3%, while small caps declined 2.0%.

Markets are trading lower due to the Delta variant increase and the potential impact for a successful re-opening of the economy. This dynamic paints a significant conundrum for public health decisions as the risks need to be considered regarding vaccinations. There is not an easy solution for government officials to address those who refuse to be vaccinated.

The S&P 500 last week endured a 1% weekly loss and finished at its lows – marking the first close on its lows since June 18th. Downside follow-through during most recent selloffs has been lacking, and we haven’t seen a 3% drawdown since mid-May.

Earnings season is likely to bring more volatility. Expectations set the bar at a point to be beaten. However, the key to continued momentum will be guidance on upward earnings revisions and is a prerequisite to a higher market.

We still believe we are in a mid-cycle transition. Also affecting the market environment, the period from the second week of July to the second week of October has historically tended to be the weakest market period of the year. So together with the mid-cycle transition, there is a recipe for potential weakness.

Market breadth turned negative last week, with 70% of the S&P500 down for the week. Sixteen names dropped more than 10%, and ninety stocks fell more than 5%; on the upside, zero were up more than 10%, and only one stock was up more than 5%. Small caps were down over 5% for the week.

Fixed Income Takeaways:

Rates markets are rallying with a risk-off mode. The 10-year Treasury is down about 7 bps, dropping below its July 8th low, currently at 1.22% and below its 200-day moving average. A double-bottom is in sight at levels of 1.19%/1.21%. These levels are significant to see if investors take a stand at that level or if yields fall further to the next support level at 1.15%. The 30-year Treasury is down sharply to 1.84%.

We see a pronounced bull-flattening bias on the yield curve. We saw it last week, and it is more pronounced today. In fact, we saw the long-end rally last week after another strong Consumer Price Index (CPI) print and Fed Chair Powell’s commitment to accommodative monetary policy at his testimony in front of Congress. With no Federal Reserve members speaking due to the blackout period in front of next week’s FOMC meeting, it might help stabilize the market.

With the movement in Treasuries, credit markets have also not been spared, albeit spreads have been relatively orderly. OAS stand at 86 basis points, the widest level since May 21. However, we have talked about spreads being in this tight range in the low-mid 80s since April. Yields remain in stable range for investment-grade (IG) bonds. High-yield spreads were unchanged on Friday but were also out 15 basis points last week.

Supply is supposed to pick up this week, with syndicate desks estimating $15-20 billion in new issue IG supply for the week. Yet, some issuers may delay coming to market to avoid some of the volatility today. July volumes for new issuance are at $47 billion. With two weeks left to go in the month, estimates are at $90-100 billion for the entire month. Those numbers are subject to change as spreads are getting volatile. The environment continues to be very favorable for issuers to come to market.

General Takeaways:

Five topics for today:

1. Inflation

   - The headline Consumer Price Index (CPI) rose 0.9% in June and 5.4% year/year – both were the largest increases since mid-2008.

   - Core CPI (excluding food and energy prices) rose 4.5% year/year, the largest increase since 1991.

   - Some of these increases are likely a recovery from last year’s declines. If higher inflation expectations were to become embedded in consumer behavior, however, some of these recent increases could prove longer lasting than expected.

   - Federal Reserve (Fed) Chairman Jerome Powell testified to Congress this week. He said that “inflation has increased notably and will likely remain elevated in coming months before moderating.” He did not signal an imminent change in monetary policy, noting that the standard of “substantial further progress” in the labor market is still some time off.

   - Shelter costs, motor fuel prices (including gasoline), used car and truck prices, and transportation costs (including airline prices) were the four major contributors to the recent spike in inflation. The spike in used car prices is likely transitory. However, an increase in shelter costs could prove “stickier” over the long term.

2. Economic Progress

   - The Fed’s monthly Beige Book report was released this week. Many Districts reported that firms continue to have difficulty finding workers, and that labor market tightness is expected to continue into the fall – a tailwind for wages.

   - Another sign of an improving labor market: weekly unemployment claims continued to fall, coming in at 360K vs. 386K the week prior. Continuing claims also fell.

   - June retail sales rose 0.6% month/month, vs. expectations of a drop of 0.4%, showing continued strength in consumer spending.

3. COVID-19

   - The US is averaging about 23,000 new cases per day, about twice the average from three weeks ago.

   - According to the Center for Disease Control (CDC), about 58.8% of American adults are fully vaccinated.

4. Corporate Earnings (see equity section)

5. Chinese GDP

   - 2nd quarter Chinese GDP rose 7.9% year/year, down from the prior quarter due to base effects, but still a very strong showing given that China’s economy held up much better than most during the pandemic.

Equity Takeaways:

Stocks rose slightly in early trading on Friday. The S&P 500 rose about 0.2%, while the Nasdaq rose 0.5%.

Small caps reacted favorably to the strong retail sales report this morning, rising 0.7%. Small caps tend to have a more domestic focus than large caps and are thus more sensitive to the US economy.

Markets tend to be forward looking, and much of the recent strong economic data is from June. US markets continue to exhibit strength, but other markets around the world are diverging by exhibiting weakness over the past month, and bond yields remain low.

Second quarter earnings season has kicked off with solid bank results. Market participants are expecting a strong earnings season to support equity prices and help resolve some of the divergent signals noted above.

Christine Lagarde of the European Central Bank (ECB) noted that the ECB will likely revise its forward guidance for its quantitative easing program in the coming weeks. The ECB will likely continue with aggressive easing for the foreseeable future.

Conversely, the Bank of England (BOE) seems to be becoming a bit more hawkish. Recent inflation numbers have been higher than expected in England.

Chinese regulators continue to squash initial public offerings for Chinese companies attempting to sell shares outside of China. China is seeking to control the data that these companies generate. Chinese regulators are also seeking to increase competition within the tech sector.

Fixed Income Takeaways:

We saw strong volume in the new issue corporate bond markets this week, with over $30B of new investment-grade (IG) deals priced. Deal flow was driven by several large financial service companies.

Environmentally and socially conscious bond issuance continues to increase. We are on track for the biggest issuance year on record in this space.

High-yield spreads moved about 7 basis points wider this week. CCC-rated paper is trading about 60 basis points wider than the tightest levels of earlier this year. Conversely, IG spreads have remained very stable since April.

Municipal bond funds continue to experience strong inflows. After two quiet weeks, the new issuance calendar picked up this week as well, with supply rising to meet demand.

Secondary trading in the municipal market remains thin. Longer-dated municipals drifted about 2 basis points wider this week in light trading.

General Takeaways:

Currently, there is significant noise around state-level COVID-19 data. Some correlation seems to exist between lower vaccination levels and higher case counts, but the results are not uniform.

The bottom line is that COVID-19 deaths have fallen significantly since the pandemic's peak, but the overall vaccination rate has slowed. According to Bloomberg, herd immunity (75%+ population vaccination) will take an additional nine months in the United States at the current level of daily vaccination. This timeline has been extended and is a bit longer than expected.

The laggards of 2020 are leading in 2021. According to Evercore ISI survey data, both airline and commercial real estate companies continue to report improving sales. In addition, overall retail sales are showing continued strength, with retailers maintaining very strong pricing power.

Survey data also indicate an improving situation for state tax receipts (a tailwind for municipal budgets). A low inventory to sales ratio also means continued tight supply across retailers.

This week, Consumer Price Index (CPI) inflation will be reported. Expectations are for a 5.1% year/year rise in headline CPI, with core CPI expected to rise 4.2% year/year. The CPI is not the Federal Reserve’s favored metric of inflation. Nevertheless, we expect this number will receive significant attention in the press, as we are currently seeing the highest core CPI readings recorded since the turn of the millennium in 2000.

As noted on Friday, China cut interest rates for the first time in many years. China had a small nominal growth recession in 2015. China has been cracking down on large technology companies, so this rate cut could be an attempt to forestall a slowdown in growth by stimulating credit (perhaps to prevent a situation similar to their 2015 slowdown).

Equity Takeaways:

The S&P 500 opened essentially flat in early Monday trading, while small caps fell about 0.7%. The Nasdaq rose about 0.2%.

One of the most important questions for stock prices going forward – will actual earnings continue to beat estimated earnings? Expectations for earnings growth in the remainder of 2021 are very high. 63% year/year earnings growth for Q2 2021 is expected.

Analysts tend to take a "wait and see" approach on earnings revisions, so it is quite possible that their 2Q 2021 estimates are too low, and earnings will come in significantly higher than expected. Based on recent trading, it appears that market participants are expecting such a scenario.

Last week the S&P 500 rose about 0.4%, it's third consecutive all-time weekly high. Despite choppiness, the market remains optimistic heading into earnings season.

Breadth was mixed last week, with about 50% of S&P 500 stocks advancing. Despite this mixed trading, Friday was a strong day which brought the cumulative advance/decline line to an all-time high – confirmation of the bullish trend.

The private equity market has entered "ludicrous" mode, with deal flow continuing to increase. Buyout multiples have remained stable, but debt loads are growing on the average deal. The public markets remain wide open – going public is becoming a more common exit strategy for private equity deals.

Fixed Income Takeaways:

After trading as low at 1.25% last week, the 10-year Treasury yield has drifted back up to 1.35% as/of Monday morning. Rates were essentially flat in early Monday trading.

Another example of the current low-yield environment: the current yield on the investment-grade (IG) corporate bond index is below 2%, below the average 10-year Treasury yield from 2000 to the present.

IG corporate spreads traded in a one basis point range during the entirety of last week, between 82 and 83 basis points (bps). Spreads have remained in the low-80s range since mid-April.

As we proceed through earnings season, we expect continued heavy issuance of corporate debt. Companies generally cannot issue bonds during their earnings blackout periods. Any temporary decline in supply could provide another catalyst to drive spreads even tighter.

Federal Reserve (Fed) Chairman Jerome Powell is set to testify in front of Congress on Wednesday and Thursday. Powell remains one of the Fed’s most dovish members and continues to believe that many aspects of the current inflation spike are transitory.

General Takeaways:

Events this week highlighted several points from Tuesday’s Investment Brief:

Much of this week’s market volatility can likely be traced to a “growth scare,” as investors question the strength and duration of the economic recovery. We believe the economy is in transition, likely from early-cycle to mid-cycle dynamics, but no recession is imminent. Transitions in leadership can cause short-term volatility but should not lead to market turmoil in our view.

In addition, headline risk between China and the United States will likely continue indefinitely. This week was no exception, with the Chinese government launching a cybersecurity probe into a large, recently listed Chinese company.

Why are long-term interest rates falling? (point and counterpoint)

1. Economic momentum is moderating.

   - We believe growth is still positive and could surprise on the upside due to excess savings.

2. Inflation expectations are moderating (Federal Reserve becoming more hawkish).

   - If the Fed erred by becoming too hawkish too quickly, we anticipate it is a mistake that can be reversed.

3. Quantitative Easing (QE) / Bond Buying (Federal Reserve suppression of interest rates).

   - We think QE also limits contagion risks.

4. Fears of a possible “fiscal cliff” in 2022 due to political gridlock leading to recession.

   - We believe this scenario is unlikely.

5. COVID-19 delta variant concerns.

   - COVID-19 has not been fully eradicated, but we foresee broad shutdowns as unlikely, and fatalities have remained low during the recent uptick in cases.

6. Crowded trades/sentiment leaning too far in one direction.

   - Sentiment reversals tend to be temporary. We interpret elevated sentiment as usually a good sign, as it means investors want to buy stocks.

Equity Takeaways:

Global stocks rose on Friday after selling off on Thursday. The S&P 500 rose 0.7% in early trading, while small caps rose 2%. International shares also rose.

European shares rose over 1% on Friday in response to a new inflation framework from the European Central Bank (ECB). The ECB will now explicitly target 2% inflation over a full cycle, which essentially means they will allow near-term inflation to drift over 2%. This new framework is designed to support economic growth.

Conversely, Asian shares continue to lag due to COVID-19 concerns, as well as increased regulation on Chinese tech and finance companies. Chinese leaders are willing to sacrifice short-term growth for more sustainable long-term growth.

The Chinese government is seeking to control all large data sets. One repercussion of this policy will be fewer listings of Chinese companies in US markets.

Several emerging market nations, such as Mexico and Brazil, have recently been forced to raise interest rates (to protect their currencies) due to inflation. At this same time, Chinese officials recently cut interest rates to stimulate the economy.

Fixed Income Takeaways:

Despite falling 10-year Treasury rates and corrections in certain commodities such as lumber and copper, investment-grade credit spreads have remained stable over the past few weeks. Stable credit spreads indicate that the recent “growth scare” may be temporary.

Fund flows continue to support spreads, with investment-grade (IG) and high-yield funds showing large inflows over the past week.

IG spreads widened two basis points (bps) yesterday to 85 basis points (bps). This 2 bps of widening was actually the most spread widening we’ve seen since March, highlighting the extremely strong environment for corporate credit.

The slope of the yield curve remains strongly positive, although it has flattened somewhat recently. A positively sloped yield curve is usually a good sign for future economic growth.

We continue to expect that the Federal Reserve (Fed) will provide further guidance on tapering at their Jackson Hole meeting in August. This week, the Fed’s June minutes were released and provided no further hawkish surprises.

The municipal bond market has been very quiet over the past few weeks. Supply is down, and many market participants are on vacation.

Despite quiet trading, money continues to pour into municipal bonds. Positive fund flows have shown in 59 out of the last 60 weeks, with over $2 billion flowing into municipals during the last week alone. For year-to-date (YTD) 2021, fund flows have been the highest on record.

General Takeaways:

Broad US equities rose over 8% in the second quarter and have risen about 15.1% year-to-date (YTD). Global equities (ex-US) have risen about 7.8% YTD.

During the second quarter, US bonds (municipal and taxable) rose between 1-2%. On a YTD basis, municipal bonds have returned about 1%, while US taxable bonds have dropped about 1.7%.

Large cap growth stocks made a comeback during the second quarter, rising 11.9%, but small value stocks continue to lead YTD. On a YTD basis, small value stocks have risen 26.9%, while large growth stocks have risen 13%.

Are economic indicators peaking while inflation continues to expand? Purchasing Manager Index (PMI) data across the globe seems to be peaking, while inflationary pressures are showing no signs of abating. The Employment Cost Index (ECI), National Federation of Independent Businesses (NFIB) pay increases, and NFIB job openings data will all be important metrics of inflation to watch in July.

Apartment rents and house prices are both “sticky” forms of inflation. House prices are rising at a historically fast year/year pace (perhaps the fastest on record). Apartment rents have also begun to rise quickly after lagging home prices for some time.

The pace of fiscal stimulus has begun to slow. At the same time, consumers have started to draw down their savings. That said, the combined Federal Reserve and European Central Bank balance sheets have expanded by over $8 trillion over the past year, to $17+ trillion – the spigots of monetary stimulus remain wide open.

What could go wrong in the second half of the year?

1. Delta COVID-19 variant spread and uneven vaccination uptake.
2. Inflation pressures leading to margin pressures and lower corporate earnings.
3. Economic growth & fiscal support peaking – transition to more sustainable growth is the likeliest outcome in our view.
4. Policy error – either monetary, fiscal or regulatory.
5. China slamming on the brakes on their economy / increased regulation.
6. Sentiment/valuations and some feelings of complacency (additional details in the equity comments).
7. Something else we don’t know.

Equity Takeaways:

Stocks were mixed in early trading on Tuesday. The S&P 500 fell about 0.5%, while small caps fell nearly 1%. The tech-heavy Nasdaq rose slightly.

The S&P 500 was up 14.3% (price only) through the end of June. Since 1950, every time the S&P 500 has been up greater than 12.5% in the first six months of the year, the average return going forward (16 times since 1950) has been over 7%, with a 12/16 positive hit rate.

Put another way, based on the first-half performance, history tells us that the market will likely continue rising as we move through 2021, but that gains are likely to be muted relative to the first half of the year. (Always keep in mind that past performance is not necessarily indicative of future results).

The market’s “summer swoon” typically begins in mid-July and runs through Labor Day. We have not seen any material pullbacks in the S&P 500 year-to-date. In 2021, we have only seen four pullbacks of greater than 3%. It would not surprise us to see a pullback during the summer swoon period, but we are not expecting a deep correction.

Equity fund flows remain robust, and valuations look expensive relative to history. Sentiment is stretched (most hedge fund exposure is in the 90th-100th percentile on gross and net long exposure). In short, market participants appear complacent.

Fixed Income Takeaways:

The 10-year Treasury yield hit 1.41% on Monday, its lowest level since early March. Low treasury yields continue to keep corporate funding costs down, leading to continued strong new issuance.

In the second quarter, investment-grade (IG) corporate bond spreads tightened 10 basis points (bps) to approximately 82 bps. Spreads are tight relative to history, and all-in yields corporate bond yields remain extremely low.

The spread between US investment-grade bonds and US high-yield bonds is currently about 182 basis points. This differential is presently at its lowest level since mid-2007.

The amount of cash in the banking system continues to balloon, which has kept a lid on money-market rates. Even out of 1-year, money market instruments are yielding less than 20 basis points.

This week, June Federal Reserve Open Market Committee (FOMC) minutes will be released.

General Takeaways:

The federal government significantly supplemented household incomes during the recent crisis. Recently, private incomes are being supported more by increasing employment and wages.

Some are concerned that the decline in government stimulus may suppress consumer spending, but currently, household income and spending are above trend.

In addition, the valuation of financial assets as a percentage of total assets in the United States is approaching an all-time high. Historically, these levels of financial asset concentration have preceded corrections in the financial asset markets. However, the timing of such is far from predictable, and today’s low interest rates may justify higher valuations.

Another example of supply issues in the labor market – total job openings are spiking higher across industries, especially within the leisure and hospitality sectors. Extended unemployment benefits will roll off in September, and many states are opting out of these programs early.

The 100th anniversary of the Chinese Communist Party (CCP) is approaching. After outperforming most of the world in 2020, the Chinese economy has pulled back slightly in 2021, but some China watchers are quite bullish on China’s long-term prospects.

Europe’s reopening is behind the US, yet many measures of Europe’s economy are beginning to inflect higher. UK retail orders, German consumer confidence, and Italian economic sentiment are all on the improve.

Due to years of recent fiscal and monetary stimulus, Japanese household credit is expanding for the first time in many years. The deflationary expectations embedded in the mind of Japanese consumers since the 1990s bust seem to be abating.

Equity Takeaways:

Stocks were mixed in early trading on Monday. The Nasdaq rose about 0.6%, with the S&P 500 essentially flat. Small caps fell about 0.6%.

The S&P 500 was up 2.7% last week, the best weekly advance since early February and its second-best weekly performance of 2021. Both the S&P 500 and Nasdaq made all-time highs last week.

Since 2019, the market has been up more than 2% in a week 21 times. In the subsequent week, the market rose 13/21 times, with an average gain of 0.5%.

Breadth was very strong on the week, with over 90% of stocks advancing. Fifteen stocks in the S&P 500 rose 10%+ on the week, with only one S&P 500 stock declining over 10%. This strong breadth indicates a healthy stock market and portends well for future returns.

Small caps once again reasserted leadership, rising 4.4% to log their fourth weekly gain of at least 4% in 2021.

After rising sharply two weeks ago, implied volatility (VIX) declined sharply last week. After trading as high as 21.8 on June 21st, the VIX had retraced to 15.8 in early Monday trading. Typically, the VIX will continue to drift lower in the week after a sharp drop.

Morningstar fund flow data indicates a continued rotation out of growth funds into value funds. Year-to-date (YTD) ending May 31, about $42 billion has moved out of large growth funds into large value funds. $42 billion represents about 2% of the total stock of large growth funds.

Active equity funds continue to experience outflows, with the difference being made up by passive funds. Active equity funds have seen $250 billion in outflows over the last twelve months (TTM) ending May 31, while passive equity funds have seen $350 billion of inflows over the same period.

In total, equities have seen about $100 billion of inflows over the last twelve months. For context, bond funds have seen $900 billion of inflows over the same period.

Key Private Bank continues to underweight fixed income in client portfolios vs. equity due to persistently low bond yields and the threat of rising inflation.

Fixed Income Takeaways:

The 10-year Treasury yield rose 5 basis points (bps) to 1.49% last week. In general, longer-end yields drifted higher last week, while the front-end of the curve remained anchored at low yields.

Due to the Independence Day holiday, we expect a quiet week in the new issue corporate bond markets. Year-to-date (YTD) issuance levels are about 30% behind last year’s record pace but are still about 30% above 2019 issuance levels.

Investment-grade (IG) spreads continue to compress, tightening one basis point to 81 bps over Treasuries last week. High-yield spreads compressed 5 basis points to 275 bps. Any lightening of supply will tend to compress spreads further in the next few holiday-shortened weeks.

Speeches by Federal Reserve (Fed) governors were held on various topics last week. Some governors are more hawkish than others. Fed Chairman Jerome Powell is one of the more dovish members. Thus, we expect the committee to lean dovish at least through the August Jackson Hole meeting.

General Takeaways:

Federal Reserve (Fed) Chairman Jerome Powell testified in front of Congress on Tuesday. Powell continued to stress the Fed’s commitment to achieving inclusive full employment for the benefit of the marginalized. He also stated that “inflation is expected to drop back towards our longer-run goal.”

A federal infrastructure bill appears to be taking shape, with approximately $579 billion of new spending and no additional taxes. That said, there are still many details to be worked out, and no final agreement is in place.

Antitrust pressure on large technology companies seems to be gaining some momentum. These companies are set to defend themselves in front of Congress in the coming months. Moreover, according to a recent Gallup poll, sentiment in favor of increased regulation of technology companies has increased since mid-2019.

Consumer balance sheets are in great shape. New home prices are up 18% year-over-year (YOY), and the Wilshire index of broad stock prices is up 43% YOY.

The core Personal Consumption Expenditures (PCE) price index rose 3.4% year/year in May, in line with expectations and reflecting the strong general situation for consumers. The month/month change was +0.5%, below expectations for 0.6% growth.

PCE inflation is the Fed’s preferred inflation metric, and the headline “miss” may at least temporarily calm fears of increasing inflation.

The US is pursuing full diplomatic relations with Taiwan. This move will undoubtedly anger the mainland People’s Republic of China. The goal is to promote free trade in the region and put mainland China on the defensive diplomatically.

Earlier this week, Brazil had its highest number of daily COVID-19 cases since the pandemic began.

Summer reading recommendation: The Psychology of Money, by Morgan Housel.

Equity Takeaways:

Stocks opened slightly higher on Friday. The S&P 500 rose 0.2%, while small caps rose about 0.5%. International stocks rose 0.5% to 1%.

All three major indices (Dow, S&P 500, Nasdaq) have put in strong performances this week, each rallying over 2%.

The banking sector is healthy. Large banks passed their recent round of federal stress tests with flying colors, opening the path to dividend increases and share buybacks. This news lifted financial shares on Friday.

Going back to 1987, there have been seven instances of the Fed hiking rates after a bottoming cycle. Three months after the initial rate hike, the market was generally flat, positive 3/7 times. Looking out over longer timeframes, the market was generally positive six months after the initial hike.

European markets traded sideways this week. That said, throughout the Eurozone, mobility numbers are at their highest levels of the year, and Purchasing Manager Index (PMI) data are at their highest readings in the last 15 years. Europe has reopened slower than the US but is making progress.

Mirroring the US Fed, the European Central Bank (ECB) wants to guard against tightening policy prematurely and is expected to continue accommodative policies for the foreseeable future.

Fixed Income Takeaways:

The bond market’s reaction to Friday morning’s downside surprise in PCE inflation was muted. The 10-year Treasury note traded with a yield of 1.52% Friday morning, up two basis points (bps).

This week, Federal Reserve governors generally tried to talk down the initial hawkish sentiment after last week’s meeting. Most of these governors have been attempting to remind market participants that the Fed is continuing to provide strong support to the financial markets and will continue to do so until the United States reaches maximum employment.

Corporate spreads remain firm, and new issuance remains robust. Investment-grade (IG) corporate bond funds have seen 33 weeks of consecutive inflows. High-yield funds also saw modest inflows.

The story remains similar in the municipal bond market, which has seen positive inflows in 57 out of the past 58 weeks.

Despite volatility in the Treasury market last week, municipal bond activity was muted. Spreads remain firm. New issuance volumes are expected to decline next week before the July 4th holiday.

General Takeaways:

The key market moves from last week:

1. Yield curve flattened sharply, with short-term yields rising as long-term yields fell.

   - 2-year Treasury yields rose 11 basis points (bps), 5-year Treasury yields rose 14 bps, while 30-year Treasury yields fell 12 bps. This type of trading activity is very unusual.

2. US dollar index jumped about 2% from a 5-year low.

   - This move was the largest weekly gain in the dollar index since the first half of 2018.

3. Inflation trades reverse: gold down 6%; copper down 8%.

   - Despite these moves in the metals complex, oil prices and credit spreads were generally stable last week, which is a positive signal for the health of the financial markets and global economy.

4. Value/cyclical sectors declined, while growth stocks were flat to slightly higher.

   - Small cap value stocks declined about 5.3% last week, while large growth stocks rose about 0.5%.

Corporate and consumer survey data remains very strong. Despite some concerns about the new COVID-19 delta variant, mobility trends continue to improve.

Inflation update: some components are likely transitory, but others may be stickier.

- Examples: Used car price inflation (which has accounted for almost half of the recent monthly surges in the Consumer Price Index) is likely transitory. Housing-related data, such as rising rents, may prove to be longer-lasting.

- Overall, inflation expectations have moderated from recent highs, but remain elevated and investors should anticipate continued volatility in the weeks ahead.

Equity Takeaways:

Stocks generally rose in early trading on Monday. The S&P 500 rose about 0.5%, while small caps rose over 1%. The Nasdaq, which significantly outperformed other indices last week, was down slightly.

Last week saw the first 1% daily decline in the S&P 500 since May 18th. Overall, the S&P 500 closed 1.9% lower on the week, its worst weekly showing since February.

The S&P 500 closed below its 50-day moving average on Friday. Recent closes below the 50-day moving average have marked significant interim trading lows.

Despite weakness in the S&P 500, the tech-heavy Nasdaq closed higher on the week, setting a new all-time high in the process. Recent trading feels rotational in nature and does not feel like capitulation.

The market is trying to flush out the nature of the long-term recovery. Last week’s rotation back towards growth stocks and away from cyclical value bears close watching. As we discussed last week, we expect value stocks to reassert leadership as the economy continues to recover.

Some of the strength in growth stocks can likely be explained by the drop in Treasury yields last week. Lower long-term yields provide a tailwind for growth stocks, which generally have long-duration cash flows.

Implied volatility (VIX) rose over 20% last week to close at 20.70. Recent short-term spikes in volatility have generally fizzled out quickly since the March 2020 lows.

The stock market tends to wobble around the start of a Fed rate hiking cycle. Rate hikes are not imminent, but it does seem like the stock market is beginning to price an initial rate hike sometime in 2022.

Fixed Income Takeaways:

After last week’s dramatic flattening, Treasury yields drifted higher in early Monday trading, with the 10-year yield approaching 1.49%, about 5 basis points higher on the session.

The spread between 5-year and 30-year Treasuries narrowed last week to its lowest level since late 2020. One week of trading activity reversed several months of reflationary steepening.

Declining Treasury yields have made the new issue corporate bond market even more attractive for borrowers.

Typically, issuance levels decline over the summer, but with such cheap financing available, we expect new issue volumes to remain robust in both the investment-grade (IG) and high-yield bond markets.

IG spreads are approximately 82 basis points, while high-yield option-adjusted spreads are approximately 286 basis points. Spreads in both markets were stable last week despite volatility in the Treasury markets.

Federal Reserve (Fed) Chairman Jerome Powell will speak in front of Congress tomorrow. In addition, about ten different speeches are expected from Fed governors this week.

General Takeaways:

The Federal Reserve Open Market Committee (FOMC) meeting this week was a shocker. The committee took on a more hawkish tone than expected, while Chairman Jerome Powell continues to be one of the more dovish members.

The median expectation on the Federal Reserve (Fed) “dot plot” is now for two rate hikes in 2023, implying faster rate hikes than the market was expecting prior to this week.

Three next steps for the Fed:

1. The Fed will likely begin explicitly talking about tapering asset purchases in the near future.

   We expect a tapering announcement to occur at the Jackson Hole meeting in late August. There is one additional Fed meeting in July before the Jackson Hole meeting, but we don’t expect a significant announcement during the July meeting.

2. The Fed may begin to acknowledge the fact that inflation may become more persistent than expected.

3. The Fed continues to focus on dislocations within the labor market. Certain pockets of the labor market remain distressed, and this situation may persist for longer than expected.

Other important news items from this week:

- Initial unemployment claims came in a bit higher than expected on Thursday, at +412K. That said, the number of ongoing unemployment benefit claims is falling sharply, and the number of workers quitting jobs is on the rise. Both metrics indicate a continually improving labor market despite some noise in the headline numbers.

- The Supreme Court upheld the Affordable Care Act against a technical challenge from certain US states.

- Juneteenth is now a federal holiday (June 19th).

Equity Takeaways:

Stocks opened lower on Friday, with the S&P 500 down about 0.75% in early trading. Small caps fell a similar amount. The S&P 500 recently failed to break out of the top end of its recent trading range, which could set us up for a longer period of sideways trading action.

The rotation into value stocks and away from growth stocks has taken a pause this week, with growth stocks outperforming. Cyclical sectors, such as industrials, materials, financials, and energy, all fell more than 2% in the five trading sessions before Friday. During the same timeframe, technology stocks were up 1.6%.

As the market continues to digest Fed policy changes, we think the equities are approaching a critical juncture that will determine market leadership over the rest of the year. We continue to believe that cyclicals will resume leadership as the economy normalizes, but we will ultimately let the data be our guide.

Friday is a “quadruple witching” day, with single stock futures, stock index futures, stock index options, and single stock options all expiring on the same day. In addition, the Russell indices are being reconstituted on Friday. Both events can cause heightened short-term volatility.

International stocks were also lower on Friday, declining between 1-2%. Emerging market equities continue to lag developed international markets, led by weakness in Chinese and Indian shares.

The European Central Bank (ECB) and Bank of Japan (BOJ) continue to signal very dovish forward policy expectations. Neither bank is expected to remove monetary accommodation for at least the next several years.

Given that the FOMC signaled a more hawkish stance than expected, and international central banks generally remain dovish, the US dollar rose significantly against international currencies this week. US dollar strength has an impact on a wide variety of global markets, including equities and commodities.

Fixed Income Takeaways:

Despite a Fed meeting that contained many new data points and moving parts, Treasury yields were stable this week. The 10-year Treasury yield began the week at 1.50%, temporarily rose to 1.58% after the midweek Fed meeting, and dropped back down to 1.50% in early Friday trading.

During their last meeting, the Fed slightly raised yields on certain types of money-market instruments to a minimum yield of approximately 0.05%.

Money continues to pour into the municipal bond market. Net inflows have been seen 56 out of the prior 57 weeks. Even if the year ended this week, 2021 would be the third-largest year for calendar inflows since the data has been tracked (approximately 30 years).

Even as treasuries rallied yesterday, municipal bond yields rose. Despite this day of unusual price action, municipal bonds remain expensive relative to treasuries.

Support for an infrastructure bill seems to be growing within the Senate, which would be another positive for municipal debt.

General Takeaways:

The Federal Reserve Open Market Committee (FOMC) meets this week, with Chairman Jerome Powell’s press conference scheduled for Wednesday. In addition, Treasury Secretary Janet Yellen will testify to Congress on Thursday.

Three Things for Today:

1. Vaccination Update:

   - At the current rate of about 1.1M vaccination doses per day, 75% of the US population will be vaccinated in another five months. If daily vaccinations stall or decline this summer, the target will be extended beyond previous estimates.

   - Global vaccine distribution has been uneven. With just over 4% of the world’s population, the US has administered over 13% of total global doses.

2. More Signs of Inflation:

   - Seaborne container shipping rates have soared and are now 547% higher than the 5-year seasonal average. (Drewry Shipping)

   - Despite recent spikes in various inflation metrics, the 2-year-moving-average of US Consumer Price Inflation (CPI) remains muted at approximately 2%.

   - We remain optimistic about our allocation to real assets (infrastructure, etc.) due to under-investment in the sector over the past several decades. Real assets should continue to perform well even if the recent inflation spike proves to be transitory.

3. FOMC Preview / Yield Snapshot:

   - The Federal Reserve (Fed) is likely to begin preliminary discussions surrounding the tapering of asset purchases sometime in the next few months.

   - Market participants will be closely watching for clues about the Fed’s future intentions during this week’s meeting (future interest rate expectations, etc.). See below for more details.

   - The US 10-year yield finished Friday, June 11, at 1.46%. With inflation running at about 2.35%, the real 10-year yield is negative, at near -0.90%.

Equity Takeaways:

The summer doldrums are here. S&P 500 futures traded in a very tight 5-point range in the overnight futures session.

Equities are essentially flat in early trading on Monday, after most indices drifted slightly higher last week.

Commodities are mixed. Crude oil is trading above $70/barrel, to a 30+ month high. On the other hand, lumber prices have dropped in recent weeks and are about 30% off their recent highs.

The S&P indices will rebalance after Friday’s closing session. These rebalancing trades can occasionally cause volatility. However, this week’s changes should be fairly limited. Later this month, the Russell indices will be rebalanced, with more significant changes expected.

Fixed Income Takeaways:

The yield curve flattened last week, with the 10-year Treasury yield dropping about 20 basis points (bps) to its Monday morning level of 1.47%, its lowest yield in about three months.

As discussed above, market participants will keenly be watching this week’s FOMC meeting. The Fed is expected to continue supporting an accommodative monetary policy stance, focusing on continuous improvement in the labor market.

Since the last Fed meeting, the economic data has been somewhat confusing, with monthly job growth missing expectations. We don’t believe the Fed will make any significant changes to guidance until the late summer Jackson Hole meeting.

The Fed is likely to be very careful with any changes to its messaging regarding asset purchases. The Fed likely learned a lesson from the adverse market reaction to their 2013 tapering announcement.

Investment-grade (IG) credit spreads are currently at 14-year lows, at approximately 84 basis points.

High-yield spreads also remain firm, with the yield-to-worst (YTW) on the high-yield index under 4%, near all-time lows. The credit markets are wide open, and corporate borrowers continue to take advantage.

Year-to-date (YTD), we’ve seen over $750B of new IG corporate bond issuance. For the full year 2021, we’re tracking towards about $1.5T of new IG issuance.

Historically, credit spreads can stay tight for extended periods of time. Within our fixed income allocations, Key Private Bank continues to look for ways to add yield in a prudent manner while maintaining a cautious stance on fixed income in general.

General Takeaways:

Four topics of interest today:

1. Taper tantrum replay?

   The question remains whether the inflationary dynamic that has accelerated in recent months is transitory or sustaining. Headline data released yesterday indicated the overall CPI for May increased 5.0% year-over-year, the largest increase since 2008; CPI excluding food & energy components increased 3.8%, the largest increase since 1992. Both numbers are subject to the base effect to some degree.

   Interestingly, higher prices are beginning to hurt demand. To wit, house sales have recently stalled, despite record-low mortgage rates, because of the surge in prices. The price of lumber has collapsed by approximately 30% recently but is still high relative to year/year comparisons.

   This dynamic is prompting investors to wonder if the Federal Reserve (Fed) may soon begin tapering asset purchases similar to 8 years ago in May 2013. Looking back, the S&P 500 Index, which had already rallied 16% YTD in 2013, stalled out from May 22nd all the way to October 8th before rallying another 12% into the end of the year. The maximum drawdown from “Taper Day” was 5 percent – the low in late June. Bond prices, however, sold off as interest rates jumped roughly 100 basis points (1%).

   So, watch what the Fed does vs. what they say they might do (or think about doing). Returning back to 2021, although the FOMC meets next week, we believe a more tangible decision would occur in August at their meeting in Jackson Hole.

2. Global reopening + global stimulus = global expansion

   According to ISI, although there has been divergence in the past, there is recent synchronization of stimulus provided by the Fed as well as the European Central Bank (ECB). Together with the Bank of Japan and other central banks around the globe, this should lead to global expansion.

3. Asset class performance during different inflation regimes

   Real assets can be beneficial during rising inflation, but timing can be tricky. Equities, TIPS and Real Estate are attractive across different environments. Real returns (returns after inflation) during various accelerating inflationary environments from 1973-2019 were positive in asset classes such as TIPS, Natural Resources Equities, REITs, and Commodities and out-paced traditional asset classes such as Bonds, US Equities and International Equities.

4. Human ingenuity is alive and well

   According to the WSJ, the FDA approved the first Alzheimer’s drug to slow the disease. Biogen’s drug was approved after facing doubts over whether it slows progression of the memory-robbing disease.

Equity Takeaways:

All three major market indices opened essentially flat in early trading.

Growth has out-performed Value for the past week. The S&P 500 is up just over 1%, while the NASDAQ is up close to 3%. Performance has been led by Growth-oriented sectors (Heath Care, REITs, Technology, Communication Services) rather than Value sectors (Energy, Industrials, Financials, Materials), which is not surprising due to the moderation in yields.

The odds may be increasing for additional stimulus related to infrastructure spending based on recent progress towards agreement in Congress.

Our view is that the backdrop for equities continues to be favorable, with the inflation caveat being the biggest risk. We will continue to watch closely.

The majority of S&P 500 stocks remain above their 200-day moving averages and the market has historically done well when there is some slack in the economy but decreasing, which is where we are now.

International markets continued to slightly under-perform US markets this week. Europe has done well while Asia continues to lag due to pandemic issues. Emerging markets have also under-performed versus Developed markets.

This week at the G7 summit, member countries agreed to tax large multi-national companies where the services are sold and agreed to a 15% global minimum tax. This would mostly affect large US Tech and Communication Services companies via digital services taxes. Continued discussion by individual countries would need to occur before legislation is finalized.

Fixed Income Takeaways:

The yield curve continues to experience a bull-flattening, with the movement lower in intermediate- and longer-dated Treasuries. The 10-year yield is at 1.45%, after reaching a low of 1.43% yesterday which was the lowest level seen since March 3rd of this year. The 10-year yield has declined 10 basis points this week, which is significant in the face of rising inflation expectations.

The ECB announced yesterday that they will maintain asset purchases until at least March of 2022, which we anticipate will cause enhanced European demand for US bonds to continue.

Even as the economy re-opens and inflation expectations rise, 10-year Treasury yields continue to remain range bound between 1.45% and 1.70% over the past two months. Treasury auctions this week all performed well and did not cause rates to move higher.

What would we need to see as a catalyst for rates to move higher? We believe a number of events would need to occur, including (1) a slow-down of foreign participation, such as Japanese/European pension funds buying Treasuries as well as (2) global yields would need to rise.

Both investment-grade (IG) and high-yield spreads remain tight. The bond markets remain conducive for new issuance. $36 billion of new debt came to market this week and volume was boosted by bank issuers.

The Municipal Bond market continues to maintain its trend. Absolute yields remain low and ratios to Treasuries remain low at 52%-64%, significantly below historical levels of 75%-80%. Fund flows continue to be positive, this week garnering $2.5 billion in inflows, which is the third highest this year and contributing to 55 of the past 56 weeks of positive fund flows.

We are also seeing a bifurcated market between new issues and secondary trading. Strong activity and deal flow exists in the primary market (volume up 12% year/year), while trading in the secondary market has decreased considerably (down 36% year/year). Contributing factors include last year’s sell-off due to the pandemic and capital gains selling this year due to the strong rally.

General Takeaways:

Five things for today:

1. Vaccinations down

   - Across the country, daily COVID-19 vaccinations in the US are declining, while the pace is accelerating in the EU and China.

2. Survey optimism higher

   - According to the ISI group, survey respondents now view inflation and higher interest rates as the greatest possible headwind to future stock market performance. Increased taxes and regulation are perceived as the second largest threat.

   - Also according to ISI, about 80% of companies plan to hold in-person meetings by the end of 2021.

   - With respect to commercial real estate, about 75% of companies believe their physical footprint will stay the same (or are undecided). 17% of companies are considering increasing their physical footprint, while only 7% plan on decreasing. (ISI, NY Regional Business Survey)

   - Both Purchasing Manager Index (PMI) and individual company surveys indicate a continued increase in pricing power for corporations.

3. The Federal Reserve (Fed) may be at a critical juncture

   - According to ISI, the Fed is likely to begin discussions of the tapering of bond purchases in either June or July. These discussions will likely be the first in a series of steps that will result in a reduction of bond purchases sometime around the end of 2021.

4. Key data point this week

   – CPI on Thursday. The European Central Bank (ECB) also meets on Thursday to discuss their continued stimulus programs.

5. NY Times Article title: The Best Investment of All: The People You Love the Most

Equity Takeaways:

The S&P 500 opened essentially flat in early Monday trading, while small caps rose about 0.5%. International shares were also flat to slightly higher.

The summer doldrums have arrived. Recent S&P 500 price action has been primarily sideways in limited volume. This type of price action is not necessarily a bad thing, as many times the market needs time to consolidate gains before moving higher.

As corporate earnings have improved while equities have traded sideways, the Price/Earnings multiple on the S&P 500 has fallen over the past few months. If higher prices for goods and services continue to translate into higher corporate revenue and earnings, the stock market will continue to have a strong tailwind.

Another positive sign – cyclicals continue to lead the market. Energy, materials, industrials and banks have been the strongest sectors throughout 2021, and this pattern has continued over the past several weeks. Overall, the stock market is healthy.

Due to strong recent performance, “meme” stocks have begun to account for an increasing percentage of passive small cap indices. As meme stocks become a larger percentage of passive indices, the outlook for active investing in small caps gets brighter (more opportunity to underweight companies with poor fundamentals).

Fixed Income Takeaways:

After a strong session on Friday that saw the 10-year treasury yield drop about 6 basis points (bps), yields are slightly higher this morning, with the benchmark 10-year trading at 1.58%. Several treasury auctions are on tap for this week which will likely influence the near-term direction of bond prices.

If inflation is rising, why aren’t bond yields rising as well? Strong continued flows into bonds are one reason, with foreign buyers as well as pension funds continuing to add to their holdings. Another reason for continued low yields is ongoing support from the Federal Reserve (Fed). KPB does expect yields to drift higher as we progress through 2021.

The Fed is likely focused on the fact that many employment sectors remain depressed relative to their pre-COVID peaks. The labor participation rate has also yet to rebound to pre-COVID levels, suggesting continued pockets of weakness in the labor market. As a result, the Fed remains loath to remove stimulus before the labor market has fully healed.

The Fed announced that they will be liquidating their corporate bond portfolio, which amounts to about $14B of corporate bonds and ETFs that were amassed during the crisis. The program was designed to reduce borrowing costs during the pandemic. The ending of this program is a small incremental reduction in overall monetary stimulus.

Both investment-grade (IG) and high-yield spreads remain stable at near historically low levels. The bond markets remain conducive for new issuance.

General Takeaways:

Five things for today:

1. COVID trends may be changing.

   - Indian case counts have declined significantly after peaking about six weeks ago. Fatalities trail cases by about three weeks and have also inflected lower.

   - In the US, vaccination uptake is skewed by age, with younger people slower to react. Overall, a little over 50% of the US population is fully vaccinated.

2. Fiscal policy may be changing.

   - On Wednesday, President Biden signaled some flexibility on his infrastructure plan. He put forward a $1T proposal, down from the initial $1.7T. To fund the plan, instead of his initial plan to boost the corporate tax rate from 21% to 28%, Biden floated the idea of a 15% minimum tax for the nation’s largest companies.

   - Republicans remain resistant to the idea of higher taxes, so the path forward for this infrastructure bill remains much in doubt.

3. Federal Reserve policy may be poised for change.

   - The Federal Reserve (Fed) is effectively unwinding one of its emergency pandemic purchase programs related to corporate bonds.

   - In addition, recent comments from NY Fed President John Williams suggest that the Fed could begin a discussion of quantitative easing tapering as early as June.

4. Speculative behavior is alive again.

   - Certain entertainment stocks exploded higher this week, with stock prices becoming divorced from fundamentals.

5. Human ingenuity is alive and well.

   - United Airlines plans to bring back supersonic flights, and recent studies indicate continued progress in the fight against both breast cancer and Alzheimer’s disease.

   More reasons for optimism:

   - In corporate America, bankruptcies are declining, and capital spending is on the rise.

   - In the labor market, non-farm payrolls rose 559K, vs. expectations of 671K, while initial claims fell. Despite a headline “miss” in non-farm payrolls on Friday, average hourly earnings rose, and labor supply constraints are causing significant noise in the monthly numbers. Overall, the labor market continues to improve.

   The “bottom line” on inflation:

   - While no one knows for sure, we expect inflation will continue to increase over the summer, prompting some anxiety. As we enter the later stages of 2021 into 2022, certain inflationary pressures (both on the supply and demand side) should fade as the post-COVID economy normalizes.

Equity Takeaways:

US equity markets have generally traded sideways over the past week. The S&P 500 was essentially flat over the past five sessions prior to Friday. Underlying corporate earnings continue to improve, however, likely setting the stage for an eventual move higher.

The stock market saw through the headline “miss” in Friday’s non-farm payroll employment report, with equities moving slightly higher after the release of the data. The S&P 500 rose about 0.6% in early trading, while the Nasdaq was up over 1%.

Market participants seem to realize that the next few months of data will contain a lot of noise, and slightly weaker-than-expected numbers may allow the Fed to keep its accommodative policies in place for longer than expected.

International markets slightly outperformed US markets this week, with Japan leading the way. Japanese markets have had a tough year overall – even after this week’s bounce, Japanese stocks have significantly trailed other developed international markets on a year-to-date (YTD) basis.

The Japanese Central Bank has limited its purchases of ETFs this year, which could be one reason for the relative underperformance of Japanese equities.

Fixed Income Takeaways:

Despite increasing inflationary pressures in supply chains and portions of the labor market, treasury yields have stabilized. The 10-year treasury yield last traded about 1.57%, about 5 basis points lower on the day after the release of Friday’s non-farm payroll number.

Global bond yields remain very low, which is likely one factor putting downward pressure on treasury yields. It is also possible that bond investors view recent inflationary pressures as temporary, although as noted above, there is a lot of noise in recent data.

Strong inflows into municipal bonds continue, which has been the theme for the past year. At the same time, June is a heavy month for maturities in the municipal bond market, which has left municipal bond investors with extra cash.

Overall, there is currently a shortage of tax-exempt new issuance relative to demand. As a result, municipal bonds are expensive. 5-year AAA municipals yield about 53% compared to treasuries. A normal ratio for 5-year AAA municipals would be 80-90% of comparable maturity treasuries.

BBB-rated municipals have outperformed AAA-rated municipals by over 300 basis points (bps) year-to-date, reflecting yield-seeking behavior as well as an increased appetite for risk.

General Takeaways:

Four things for today:

1) New COVID cases in the US reached their lowest level since last June, while US mobility data tracked by Apple reached its highest level since the pandemic began. Global cases are down 40% since April. At the same time, vaccinations in the US have declined, extending the timeline for projected herd immunity to approximately 5 months from now to cover 75% of the population. Elsewhere, however, vaccinations are on the rise including parts of Europe, Japan and China.

2) We are almost to the half-way point for the year and equities are still ahead, with both global equities and US equities outpacing bonds by more than 10 percentage points YTD through May. US Small-cap Value stocks are leading the market at a 27.5% return YTD. Within market sectors, Energy and Financials are up almost 40% and 30%, respectively.

3) Bi-partisanship may be over, as President Biden unveils the $6 Trillion Spending Plan, while the margin of majority in US Congress for a 1st Term Democratic President is the narrowest in the past century at 3 seats in the House and 1 seat in the Senate.

4) Strong economic activity continues in many areas and inflation is heading higher in the short-run.

The US Employment Cost Index rose 3.7% (annualized) for the first quarter of 2021 and is anticipated to move higher toward 4.0% for the second quarter.

Last week’s release indicated US initial unemployment claims fell to 406,000 – the fourth consecutive week of declines and reaching a new low since the pandemic began.

Also, last week, US Personal Consumption Expenditures (PCE) Index for April showed a 3.6% year-over-year increase, while Core PCE (excluding food and energy) was up 3.1%.

However, it is worth noting that the 2-year annualized average, that considers both the pandemic-related decline in prices and the subsequent rebound, shows Core PCE at approximately 2.0%, closer to long-term averages.

Recently, rising home prices have been a drag on confidence measures and some housing market data have weakened. Lumber prices have moved significantly lower as a result.

The cure for higher prices might just be higher prices.

Equity Takeaways:

Stocks rose slightly in early trading on Tuesday, with the S&P 500 up about 0.2% and the Dow rising about 0.3%. Technology stocks were flat to mildly down in early trading, with the Nasdaq declining just under 0.2%.

Activity continues to pick up for consumers across the economy as business restrictions due to the pandemic continue to get lifted. PMI data continues to support the recovery and raw materials prices are pushing higher.

Global stocks continue to rise due to ample liquidity, while the market waits for jobs data later in the week.

Following strong monthly gains in March and April, the S&P 500 Index’s 0.55% gain in May was the smallest monthly move since January 2020. Although minimal, it represents the fourth consecutive month of positive returns. As a result, we believe it would not be a surprise to see a pause in the market during the summer prior to seeing an upturn resume in the back half of the year.

Various index reconstitutions typically occur in either May or June and will result in changes to the weightings, factors, and/or sectors within several key market indices. The changes may surprise some investors, but it is fairly normal for swings in weightings to occur and recently reflect shifts in market leadership from Growth to Value.

Fixed Income Takeaways:

Two Fed speakers will opine today and our belief is they will continue to describe inflation as transitory. Some of this messaging over the past week appears to have resonated with investors, as the 10-year yield has stabilized and remained range-bound, currently at approximately 1.62%.

Issuers continue to take advantage of the market environment, with approximately $143 billion in investment-grade (IG) new issuance for the month of May. Borrowers continue to benefit from bringing supply to the market to satisfy some of the investor demand.

Investment-grade (IG) corporate bond issuance continues at a strong pace. YTD total inflows into IG funds is $92 billion, with positive flows over twenty-one consecutive weeks. We have not seen any outflows; however, the amount of inflows last week was the lowest of the past twenty-one weeks, potentially indicating some investor fatigue.

US High-grade credit spreads have an option-adjusted spread (OAS) of 84 basis points over Treasuries, hitting a 14-year low last Friday. Investors are balancing between inflation fears and the positive momentum of the economy re-opening. The last time IG spreads were at this level was in 2007, so it may be something to keep an eye on.

On the short-end of the curve, even though Fed policy is keeping a floor on short-term rates, yields may have room to drop further, possibly near or at 5 basis points. A number of factors are contributing to this, including reserve growth over the next few months, the central bank’s ongoing asset purchase program, the flow of pandemic stimulus payments to taxpayers and federal relief payments to state and local municipalities.

General Takeaways:

Four things for today:

1. About half of the US population is now vaccinated, but statistics vary significantly by state/region.

2. It’s shaping up to be a hot summer, and not just in terms of temperature.

   - OpenTable restaurant data and TSA checkpoint crossings both recently hit post-pandemic highs.

   - Markit Composite Purchasing Manager Index (PMI) data surged to 68.1% in May, a record high.

   Recall that any reading above 50% indicates economic expansion. The Composite PMI combines data on both the services and manufacturing sectors of the US economy.

   - The Federal Reserve’s (Fed) balance sheet continues to expand – it increased $92 billion last week and is set to increase by $120 billion per month through the end of the year, if not longer.

3. Case for active management has recently improved.

   - Longer-term correlations have fallen back to their long-term median and are below their typical levels since the Great Financial Crisis. This type of environment improves the outlook for active management.

   - In addition, the earnings of value stocks have improved relative to the earnings of growth stocks since mid-2020 (relative earnings trajectory of value stocks has improved relative to growth). Value stocks continue to trade at a very wide discount to growth stocks on a Price/Earnings basis. These dynamics set up some interesting opportunities for active managers.

4. Asset allocation uncertainty amidst various inflation regimes.

   Inflation remains a significant concern among market participants. While we continue to see rising prices in many commodities, it is important to note that other measures of inflation remain relatively muted.

   Unit labor costs are up about 1.6% year/year, in line with historical averages, while productivity has increased sharply over the past year. Capacity utilization is about 75%, and U6 unemployment is over 10% - both numbers imply slack in the economy.

   In short, it remains to be seen whether the recent spike in inflation will be permanent or transitory.

Equity Takeaways:

Stocks rose in early trading on Monday, with the S&P 500 up about 0.7%. Technology stocks led the way in early trading, with the Nasdaq rising about 1%, while small caps rose about 0.5%.

The S&P 500 was essentially unchanged last week despite some intra-week volatility. Trading activity was muted, and the market continues to back and fill. Choppiness will likely prevail until we can break out of the recent trading range.

We are also approaching the summer doldrums, where trading volume will likely decline.

Last week, 62% of stocks declined. In the week before last, 65% of stocks declined. Breadth has been weakening over the past several weeks but has not turned severely negative. This price action is another indication that we will likely see some choppiness as we head into the summer months.

Fixed Income Takeaways:

Three Treasury auctions (Tues, Weds, Thurs) will set the tone of the Treasury market for the week. The 10-year Treasury note has recently traded in a tight range, yielding 1.62% as/of Monday morning.

Market participants continue to focus on speeches from Fed governors. Recently, the Fed has attributed much of the current inflationary pressures in the economy to transitory supply chain issues. Any change in this stance could cause large ripples in the bond market.

Investment-grade (IG) corporate bond issuance continues at a strong pace. In the meantime, spreads continue to tighten. IG spreads were about seven basis points tighter last week.

Over the past few years, high-yield bond issuance has been relatively muted. That dynamic has changed dramatically in 2021. High-yield issuers are taking advantage of wide-open capital markets by issuing new bonds at a furious pace.

General Takeaways:

The US Federal Reserve (Fed) provided some mixed messaging this week as they seek to maintain their outcome-based policy stance. The Fed appears to be “thinking about thinking about” changing forward guidance on their pace of bond purchases.

Indeed, this week’s Fed minutes indicated several governors felt that “… it might be appropriate at some point in upcoming meetings to begin discussing a plan for adjusting the pace of asset purchases.”

Key Private Bank feels that an official tapering announcement will likely not occur until the Federal Reserve’s annual meeting at Jackson Hole in August, with official implementation occurring months after the initial announcement.

Five Things for Today:

1. White-hot economic data has cooled somewhat but remains hot. Recent measures of employment, retail sales, and housing starts all trailed expectations.

2. Despite moderating data, US CEO confidence is at an all-time high, which bodes well for CAPEX, M&A, and hiring. Supply chain issues and increasing inflation could put a damper on some of this activity, though.

   • Many states have begun to opt out of the federal unemployment benefits extension program in response to increasing worker shortages. In total, about 1/3 of the US labor force resides in states that have opted out. Expanded federal unemployment benefits expire in September.

3. Europe’s economy is improving, while Asia remains shaky. Several large Asian economies are experiencing COVID-19 lockdowns as they attempt to prevent larger outbreaks. In addition, Chinese industrial production and retail sales both weakened in April.

4. Stimulus (both fiscal and monetary) may be on the cusp of fading – see above comments regarding the Fed.

   In addition, the pace of US federal outlays inflected lower in April for the first time since the beginning of the pandemic.

5. COVID-19 policies in the US are confusing – more clarity is needed as the economy continues to reopen.

Equity Takeaways:

Stocks rose in early trading on Friday. The S&P 500 rose about 0.5%, with small caps up about 1%. International stocks also rose about 0.5%. This morning’s price action builds on a positive Thursday session, which saw the S&P 500 rise over 1%.

Yesterday’s strong price action stopped a 3-day losing streak for the S&P 500. Growth and momentum stocks led the way, with the Nasdaq rising about 2%.

Despite a strong week for technology stocks, value stocks are still outperforming growth stocks year-to-date (YTD). Value stocks are up about 16.4% YTD, while growth stocks are up about 6.9% YTD.

The number of S&P 500 companies above their 50-day moving average is just over 60%. Earlier this year, this number was over 90%. In general, the S&P 500 has a bias towards growth stocks.

Corporate margins have reached all-time highs, and S&P 500 companies beat bottom-line analyst estimates by over 20% on average in the past quarter. Despite these very strong earnings, the market reaction has been somewhat muted, as concerns about future inflation have become a headwind to the markets.

European equities have started to show some signs of life. The Euro Stoxx 50 (an index of the Eurozone’s largest companies) recently hit its highest level since 2008.

In addition, European bank earnings beat (albeit low) expectations by an average of over 20% in the last quarter. Emerging market equities have also had a great week, rising more than 2.5%.

Chinese equities are the exception and continue to lag. As we’ve noted in the past, Chinese economic data was very strong relative to the rest of the world in 2020. As the rest of the world catches up, Chinese data has looked relatively weak over the past several months.

Fixed Income Takeaways:

Increasing near-term inflation will likely result in a further steepening in the yield curve. With the 10-year Treasury yield at 1.63%, the 2-year / 10-year spread is currently 148 basis points, and we expect this differential to widen.

The current situation in the bond market has some similarities to the setup before May 2013’s “taper tantrum.” May 2013 was when Fed Chairman Ben Bernanke first hinted at the tapering of bond purchases after the Great Financial Crisis.

Yields initially spiked higher after Bernanke’s comments but then began to slowly drift lower. Equities also experienced some volatility after his remarks, but stocks still rose significantly in 2013 to put in the strongest calendar year performance of the entire 21st century to date.

The story remains the same in corporate bond land – issuance remains high, and spreads remain tight. Investment-grade (IG) corporate bond funds continue to see strong inflows as investors search for income and safety.

Despite continued strength in IG paper, high-yield bonds have shown mild price weakness over the past several weeks, mainly in response to very heavy new issue supply. High-yield bond funds have seen outflows for the past three weeks.

Municipal bonds have seen positive net flows in 52 of the past 53 weeks. Year-to-date, net flows into municipals have topped $45 billion, which is a huge number relative to history. These flows have continued to drive spreads tighter. Overall, municipals remain expensive relative to Treasuries.

In the quest for yield, municipal bond investors have also begun to pull money out of shorter-dated high-quality securities. These investors are extending out the curve and are also purchasing bonds from lower-quality issuers.

General Takeaways:

Equity Takeaways:

Fixed Income Takeaways:

General Takeaways:

Employment update

Jobless claims fell to a new cycle low this week (although they are still elevated relative to pre-COVID numbers). Underneath the surface, we see some positive signs for the labor market. Job openings are increasing rapidly, and the quit rate is also moving higher. Layoff announcements are plummeting, and small business optimism is improving rapidly.

These data points all paint a similar picture that the soft May non-farm payroll employment number reported last week was likely a fluke and that the labor market continues to improve steadily.

Inflation: Transitory vs. Permanent?

Earlier this week, we learned that headline Consumer Price Inflation (CPI) rose 0.77% in month/month April, resulting in a 4.2% year/year increase in this metric. The core CPI (which strips out food and energy) surged 0.92%, which translates into a 3.0% year/year gain.

Used vehicle prices rose at an annual rate of 21% in April. Without used car inflation, headline CPI would have been +3.6% year/year, and core CPI would have been +2.3% year/year (instead of +3.0%).

Other examples of price increases reported in the April data (year/year percentage increases):

• Gasoline: +49.6%
• Rental Cars: +16.2%
• Airline Fares: +10.2%
• Hotels: +7.6%
• Public Transportation: +5.8%
• Sporting Events: +3.4%
• Clothing: +0.3%
• Owner Equivalent Rent: +0.2%
• Healthcare Services: Flat

Key Private Bank believes that recent patterns in the economy and stock market suggest that as inflation turns higher, it will likely persist longer than expected. We don’t expect “scary high” inflation, with the caveat that current monetary & fiscal policy is an experiment, and we will continue to monitor the data closely.

Our advice remains focused on patience and long-term wealth creation. We continue to recommend that investors stay diversified while tilting portfolios towards cyclical exposures that should benefit from increasing inflation.

Equity Takeaways:

After a sharp dip on Wednesday, the market found its footing on Thursday and is rising once again in early Friday trading. The S&P rose about 1.1% Friday morning, with small caps up a similar amount. All 11 major S&P sectors rose in early Friday trading.

Key Private Bank has been repositioning portfolios in a more cyclical manner since mid-2020 in anticipation of an economic recovery (and ensuing inflation). Federal Reserve (Fed) policy remains loose, and the Fed will likely let inflation run above the long-term 2% target, which should be a tailwind for equities all else equal.

Inflation has a sizeable behavioral component. If consumers believe prices will continue to rise over the intermediate to long-term, they may modify their purchasing patterns. Such a shift would have significant implications for certain sectors of the market – companies with operating leverage that can pass through price increases will benefit the most.

Earlier this week, the European Central Bank (ECB) mentioned that they are targeting 2% long-term inflation.

Recent readings are well below 2%, so this target is mostly aspirational at this point.

In Japan, there is no measurable inflation. In China, producer prices rose by more than 6%, but consumer prices rose only 0.9%. China is a large exporter and can generally pass much of its producer price inflation to its end customers, including the US.

Fixed Income Takeaways:

The hot CPI print earlier this week caused bond yields to rise immediately. The 2-year – 10-year Treasury spread reached 149 basis points (bps) but is still below its widest level of 162 bps set in late March.

This morning, the 10-year Treasury yield is slightly lower, at 1.64%. The US Treasury conducted a series of successful bond auctions this week, which show continued strong demand for Treasuries.

Despite the higher-than-expected CPI number reported earlier this week, Fed governors have remained consistent in their message. The Fed believes that future inflation expectations remain well-anchored and that there is significant slack in the labor market. The Fed continues to believe that recent increases in inflation are explained primarily by transitory factors.

Market participants do not completely believe the Fed’s message. Market measures of interest rate expectations, such as Fed Funds Futures, predict that the Fed’s initial rate hike will occur in either late 2022 or 2023. Most Fed governors are projecting very limited rate increases until 2023 at the earliest.

Corporate bond spreads remain tight relative to historic levels, and the amount of leverage in the system is high. Should credit trends weaken, there is a chance that ratings agencies could be quick to downgrade.

The municipal bond market had another quiet week. We continue to see historically low ratios of municipal bond yields to Treasuries. Municipals are expensive no matter what your tax bracket is.

Inflows continue into municipal bond funds despite low absolute and relative yields. Municipals offer safety and tax avoidance, which both remain in high demand by individual investors.

Similar to the corporate bond market spreads on municipals remain tight. June, July & August tend to be strong technically due to low overall new issuance and a high amount of overall maturities, so we could see continued strength into the summer.

General Takeaways:

Friday’s disappointing employment report was probably a fluke, as there was a sizeable seasonal revision component that may have created some significant noise in the data. On a non-seasonally adjusted basis, more than 1 million jobs were created in April. Seasonal adjustments were then applied – these adjustments included data from April 2020, where a significant number of jobs were lost and may have skewed the April 2021 adjusted data lower.

Other recent employment data has been strong and does not corroborate Friday’s weak number. Layoff announcements have significantly dropped. According to the National Federation of Independent Businesses (NFIB) April report, about 44% of all small businesses are having trouble filling open jobs, a record level for this survey indicator.

In addition, the US Employment Cost Index (ECI) showed the first quarter of 2021 total compensation growth at a 3.7% q/q annualized rate. This ECI reading is the highest since before the Great Financial Crisis of 2008.

Inflation update: The price of various raw materials, such as lumber and copper, continues to spike. Rents have also inflected higher since the beginning of 2021. Gains in productivity will be one key towards managing future inflation. Indeed, productivity growth was 4.1% in the 2021 first quarter, its highest level of quarterly growth in about a decade.

Progress against COVID-19 continues unevenly. Globally, over 20 million vaccine doses are being administered daily. According to Bloomberg, it will take another 16 months to cover 75% of the population at this pace. India is administering almost 2 million cases daily. However, due to the country's large size, it will still take about 2.7 years to inoculate 75% of the Indian population.

Signs of froth: according to the Wall Street Journal, the combined market value of all cryptocurrency has eclipsed total US currency in circulation (more than $2 trillion). In addition, Tesla’s market capitalization is larger than the next five largest automakers combined.

Bitcoin has likely taken some market share from gold recently, while tokens such as Ethereum have applications in Decentralized Finance (DeFi). Ethereum can also help facilitate non-fungible tokens (NFT) trading, which are becoming increasingly popular.

Equity Takeaways:

Stocks opened mixed in early trading on Monday. The S&P 500 dropped about 0.10%, with small caps dipping a similar amount.

Technology shares fell about 1%.

Equity market investors seemed to shrug off last week’s disappointing non-farm payroll data, as the S&P 500 rose about 0.75% on Friday, and rotation continued towards cyclical sectors of the market even after the release of the data. As noted below, the bond market sent a similar signal on Friday, with rates initially spiking lower before drifting higher in the afternoon to close unchanged.

A weekend cyberattack on the main pipeline carrying gasoline and diesel fuel to the US East Coast is also impacting the markets on Monday, with shares in the energy sector rising over 1.5% in early trading.

The first-quarter earnings season is winding down. As of Friday, 88% of S&P companies have reported. Of these, 86% have beaten analysts’ expectations, the highest beat rate on record back to 2008. 76% of reporting companies have beaten revenue estimates for the quarter.

Fixed Income Takeaways:

The 10-year Treasury yield settled in at 1.58% last week after trading as low as 1.47% immediately after the release of Friday’s non-farm payroll number. Bond prices are essentially unchanged in early trading on Monday.

The US will be auctioning several different tenors of Treasuries this week. The reception of these deals often has a significant impact on short-term moves in the Treasury markets. We expect a busy week of corporate bond issuance, with several large companies set to price deals.

Investment-grade (IG) corporate bond spreads have tightened to a 3-year low, with the broad index trading at 87 basis points (bps). Foreign investors remain a significant source of demand due to low overseas yields.

High-yield bond spreads also contracted again last week. Supply is rising to meet this demand, with the pace of high-yield issuance during the first half of 2021 approaching record levels.

During speeches last week, several different Federal Reserve governors continued to downplay inflation fears, noting that the Fed does not have any near-term plans to slow their current pace of stimulus.

General Takeaways:

This week, investors received several major economic data points. ISM Manufacturing PMI data for April was reported at 60.7, vs. March’s reading of 64.7. Recall that any number above 50.0 indicates expansion.

A few days later, ISM Services activity was reported at 62.7, vs. March’s reading of 63.7. These reports indicate continued strong growth in the economy's manufacturing and services sectors (although both reports were slightly below expectations).

On Thursday, weekly US jobless claims were reported at 498,000 (vs. expectations of 527,000), the lowest since March 2020.

On Friday, US non-farm payrolls were reported. Total non-farm payroll employment rose by 266,000 in April, a major miss relative to expectations of a rise of 1 million jobs. We will be digging into the underlying numbers over the next few days, but at first glance, this miss appears to be driven by a worker supply issue.

Despite Friday’s non-farm payroll miss, two major themes have been dominating recent market activity:

1. Economic activity is booming (but the Fed is standing pat for now). According to ISI:
   - GDPNow (a measure for estimating economic growth) for the second quarter is +13.6%.
   - Vehicle sales surged to 18.5 million in April.
   - Nominal consumer spending surged +14.6% q/q annual rate in the first quarter.
   - WTI crude oil is at about $65 today vs. $24 one year ago.
   - Lumber prices are up to $1,635 vs. $300 one year ago.
   - ISI’s proprietary company surveys have been surging.

2. Equity markets are rotating (and perhaps becoming more volatile):
   - Growth stocks with little or no current profits have suffered significant headwinds over the past several months, while cyclical stocks, such as energy, materials, industrials, and financials, continue to outperform on a relative basis. More on this theme below, which continues to inform Key Private Bank’s recommended portfolio positioning.

Equity Takeaways:

Friday’s trading will revolve around this morning’s shocking non-farm payroll miss. In early trading, the S&P 500 rose about 0.5%, with small caps essentially flat. The tech-heavy Nasdaq, which tends to be sensitive to interest rates, rose 0.8% as the 10-year Treasury yield fell in early trading.

This morning’s trading notwithstanding, growth stocks (especially non-profitable growth companies) have significantly underperformed their cyclical counterparts over the past 3-6 months. This is a trend that we expect to persist over the short to intermediate-term as the economy recovers.

The level of margin debt held by investors hit an all-time high in March 2021. That said, the overall level of margin debt tends to be closely linked to the size of the overall stock market. While the recent rise in margin debt is the largest in absolute terms, it is not as large on a relative basis as the moves we saw in 2000 and 2007. In both of those years, the rise in margin debt outpaced the total gain in market cap.

Earnings season update: Over 70% of reporting companies have beaten analysts’ 1Q:2021 revenue estimates, with only 19% missing on revenue. More than 80% of companies have beaten estimates on the earnings front, with only 11% missing.

Companies (especially growth stocks) guiding towards any type of earnings deceleration are seeing their stocks sell off sharply. Investors appear to be somewhat discounting this quarter’s strong earnings, becoming more focused on the future.

Emerging market equities are facing two major headwinds. India continues to experience a major COVID-19 outbreak. In addition, Chinese stocks, which were significant outperformers in 2020, continue to struggle on a relative basis in 2021.

While China is a major consumer of raw materials, China is also a notable exporter and has been able to pass price increases through to their end customers. China’s GDP growth is expected to top 8% this year after 2%+ growth in 2020 (a year where most world economies contracted). This growth should bode well for the future performance of China’s stock market.

Fixed Income Takeaways:

Before the non-farm payroll number was released on Friday morning, the 10-year Treasury yield was 1.57%. Immediately after the number was reported at 8:30 am ET, the 10-year yield dropped to 1.47%, but rates settled down quickly and, at the time of this writing, were trading at 1.54%.

On Tuesday morning, US Treasury Secretary Janet Yellen said: “… it may be that interest rates will have to rise somewhat to make sure that our economy doesn’t overheat ….”

Later in the day, Yellen walked back those comments, remarking: “… I don’t think there’s going to be an inflationary problem. But if there is, the Fed [US Federal Reserve] will be counted on to address them….”

Federal Reserve officials quickly rebutted those comments, with Vice Chair Richard Clarida stating that the Fed is not ready to begin removing stimulus. The next Federal Reserve meeting is on June 16th.

Between now and the next Fed meeting, we will receive one more monthly non-farm payroll employment reading.

This morning, spreads are opening slightly tighter once again, continuing a recent pattern of slowly grinding lower. This type of environment is conducive to new issuance, which remains robust in both the investment-grade (IG) and high-yield markets.

High-yield bond funds experienced outflows of $1.4 billion last month. Despite these negative flows, high-yield spreads remain at very tight levels relative to history.

Another $2 billion flowed into municipals last month, bringing cumulative year-to-date net flows to $44 billion. Investors continue to seek tax-free income, despite very low municipal yield ratios relative to Treasuries.

The municipal new yield calendar remains robust and contains a significant number of taxable deals. This week’s Key Questions discusses a growing and misunderstood area of bond land: taxable municipal bond debt.

General Takeaways:

The book is closed on April 2021, and global equities enjoyed a strong month, rising 4.2%. US stocks rose 5.3% on the month, with global ex-US equities rising 2.7%. Global bonds rose about 0.8% during the month.

On a year-to-date (YTD) basis, US equities have risen 11.8%, global ex-US equities have risen 5.7%, US taxable bonds have dropped 2.6%, and US municipal bonds have risen 0.5%.

April was also a month of reversals. US large caps rose 5.4% during the month, outpacing small caps, which rose 2.1%. YTD, small caps have still outperformed large caps, rising 15.1% vs. 11.6% for large caps.

Growth stocks, which have lagged recently, put in a strong month in April, up 6.8%. Despite a strong April for technology shares, cyclical sectors of the market, such as energy and financials, have significantly outperformed technology shares YTD.

Equity sentiment indicators remain stretched. For example, stock allocations among US households have reached an all-time high at 41%. Margin debt balances have also reached an all-time high, at $823B.

After such a strong start to the year, investors may ask if they should sell in May and go away? We don’t think they should. Stock market volatility is the norm, but it pays not to overreact. Key Private Bank generally advocates periodic rebalancing but not full-blown market timing.

Economic momentum remains strong and is supporting equities. Real GDP rose 6.7% in the first quarter, while nominal GDP (adjusted by a price deflator) rose 10.7%. Furthermore, many economists expected even more substantial growth in the second.

Stimulus payments have caused a sharp rise in disposable personal income (DPI), translating to higher consumer spending. The US personal saving rate was 18.8% in March, likely an all-time high in this metric, which bodes well for continued future strength by the US consumer.

According to ISI, spending preferences are shifting over the past few months, with activity in COVID-sensitive sectors (leisure, hospitality, etc.) beginning to improve. There is room to run for COVID-sensitive sectors, as spending in these areas remains depressed relative to long-term averages.

Equity Takeaways:

Stocks rose in early trading on Monday. The S&P 500 rose about 0.6%, with small caps up 1%. International shares also rose slightly as the European Union discussed the relaxation of certain COVID-19 restrictions.

Earnings momentum remains very strong, with 86% of reporting S&P 500 companies having beaten analysts’ estimates, the highest beat rate since FactSet began tracking the data in 2008. 78% of these companies have also reported better revenue growth than expected.

Overall, the index is on track to show over 45% earnings growth for Q1:2021 versus the same quarter last year. This number is the highest quarterly comparable since the first quarter of 2010.

Market participants are eagerly anticipating this Friday’s update on US non-farm payroll employment. As we discussed last Friday, it appears that this Friday’s report could come in significantly higher than expectations.

Over the last 20 years, profit margins have remained elevated at the expense of stagnant wages. In the past year, increased fiscal spending has supported profit margins and disposable personal income, leading to an explosion in corporate profits.

Fixed Income Takeaways:

Corporate credit spreads continued to grind tighter in April in both investment-grade and high-yield bonds.

That said, high-yield spreads are not yet to the all-time lows seen in May 2007.

US Treasury prices also rallied in April. The yield on the 10-year Treasury note dropped slightly over 10 basis points (bps) on the month, to early Monday trading level of approximately 1.63%. Overall, bond returns were generally slightly positive in April.

April was also a “stay the course” month for the US Federal Reserve (Fed), which left rates unchanged at very low levels and did not modify their accommodative forward guidance. This week, a series of Fed governors are set to speak, but we are not expecting any changes to the long-term outlook.

General Takeaways:

43% of the US population has received at least one dose of a COVID-19 vaccine, and reopening is progressing throughout the country. 30% of the US is now fully vaccinated. It will take another three months to cover 75% of the US population at the current pace.

That said, while COVID-19 case growth is moderating across North America, case growth in Asia continues to expand. India continues to deal with a dire situation, while areas such as Turkey are also seeing worsening outbreaks. This situation is likely to hamper emerging market economic growth over the near term.

President Biden released the next phase of his economic stimulus plan, with over $5T of new spending planned for the next decade. Some are comparing the current environment to the “New Deal” era of the 1930s.

One significant difference between the eras is that President Franklin Roosevelt enjoyed a large majority in Congress, while Biden’s margin is razor-thin. Thus, much of Biden’s announced plan is likely aspirational and is unlikely to pass in its current form without significant compromise.

The Federal Reserve (Fed) released an updated policy statement this week. During Chairman Jerome Powell’s press conference, no significant policy changes were announced. The Fed continues to be laser-focused on the progress of the employment market.

Recent economic data leads us to expect a very strong non-farm payroll report next week. Annualized real GDP rose 6.4% quarter/quarter annualized rate, while both weekly claims and unemployment insurance disbursements continue to drop.

The M2 money supply is rising at an unprecedented rate. Since early 2020, the sum of the Fed and European Central Bank balance sheets has increased almost $8 trillion. In the same timeframe, Consumer Net Worth has increased a staggering $27T.

It is not surprising that such money supply growth would lead to asset price inflation. The Fed’s preferred definition of inflation, CPI, has risen a modest 2.6% in the past year. During the same timeframe, the median US home price has risen 17%, the S&P 500 has risen 48%, copper has risen 85%, oil has risen 272%, and lumber has risen 286%. Asset price inflation indeed!

Equity Takeaways:

Stocks dipped slightly in early trading on the last day of April. The S&P 500 dropped 0.4%, with small caps down a similar amount.

International shares fell about 0.5%.

The S&P finished at another all-time high yesterday, also closing above 4200 for the first time. The cumulative advance/decline line also hit another all-time high (strong breadth continues).

In general, companies have been reporting very positive earnings growth during the quarter. With 71% of companies reporting, earnings growth for the S&P 500 has been 44%. This is stellar growth - well above expectations.

The strong GDP growth we see in the overall economy is flowing directly through to the corporate bottom line. As positive data continues to flow, analysts are now beginning to increase earnings estimates for 2022. Analysts are also starting to factor higher taxes into their 2022 estimates, a topic we discussed in this week’s Key Questions.

Key Private Bank continues to believe that the strong economic environment favors cyclical stocks (industrials, financials, basic materials) vs. defensive sectors of the market (consumer staples, utilities). This view continues to inform our portfolio construction process.

Implied volatility (VIX) has declined below the critical 20.0 level to its current level of 18.0. The stock market seems to be reentering a lower volatility, “grind higher” environment.

Fixed Income Takeaways:

Treasury yields have risen this week in sympathy with rising inflation expectations. That said, during April, Treasury prices are generally slightly higher – yields have stabilized, with the 10-year note trading at 1.65% early on Friday.

During this week’s meeting, the Fed kept policy unchanged. They continue to describe increasing near-term inflation as a transitory phenomenon. The Fed continues to look for “substantial further progress” in the labor market before they will contemplate a change in rate policy and/or tapering of bond purchases.

Corporate bond spreads remain tight, and credit volatility is low, a perfect environment for new issuance. April is set to be the fifth busiest month on record for high-yield bond issuance.

The riskiest portion of the high-yield market, CCC-rated credit, has gained for 13 straight months. That is the longest streak of positive monthly returns in CCC-rated credit since 1992. The yield on the CCC-rated index is approximately 6.1%, approaching historic lows.

The municipal bond market was quiet this week, with yields trending slightly higher in sympathy with rising Treasury yields. Municipal bonds remain very expensive. 5-7 year municipal bonds yield only 50% of comparable maturity Treasuries. Despite this fact, municipal bond fund inflows continue as investors seek tax-free income.

General Takeaways:

India remains far and away the largest contributor to COVID-19 case growth. Over the past week, India has accounted for about 34% of global cases, with more than 1 million people having contracted the virus in the last three days alone.

Conversely, there are some signs of hope out of the UK / EU. Collectively, these two areas account for about 19% of global case growth, and new cases are generally on the decline in this region.

The US is the 3rd largest contributor to global cases, but as in Europe, daily new cases appear to be inflecting lower. Overall, more than 80% of the US population aged 65+ has been vaccinated, which is helping to keep the fatality count down. Indeed, state health officials throughout the US are now shifting their attention to vaccine promotion to ensure that the US reaches herd immunity.

Between $5 trillion of fiscal stimulus, over $3 trillion of Federal Reserve (Fed) balance sheet expansion, and over $3 trillion of above-trend money supply expansion, the US has seen over $11 trillion of stimulus added to the economy over the past 12-15 months. This amount is over 50% of GDP. In contrast, FDR’s New Deal spending accounted for about 40% of GDP.

This stimulus appears to be supporting corporate earnings. The COVID-19 profit recession was the shallowest in 30 years. Earnings-per-share dropped about 15% peak-to-trough in 2020. In the 2007-08 financial crisis, earnings dropped 45% peak-to-trough.

Inflation update: market participants continue to debate whether increasing inflation is transitory or structural. Wage growth remains the central focus of this debate.

The National Federation of Independent businesses recently surveyed 500 small businesses and reported that 42% of them had job openings that they couldn’t fill – a record high. Also, many restaurants are offering signing bonuses/perks, and several large companies are beginning to pass through raw material price increases to their customers.

On the other hand, the US Council of Economic Advisors cautions that real average wages could fall over the near term as more low-wage workers re-enter the labor force. Put another way – more low-paying jobs were lost during the crisis, and as the economy continues to reopen, those jobs will need to be filled.

Equity Takeaways:

US equities opened slightly higher on Monday. The S&P 500 rose about 0.25%, with small caps up about 1%. International shares also rose slightly.

Last week saw a slight decline in US equities, although Friday marked the closing high for the week. Small caps outperformed large caps, while large cap technology shares lagged the market. Despite the slight price decline, 76% of S&P 500 stocks finished higher last week. Breadth remains strong.

Earnings season continues. This week features a packed calendar, highlighted by the reporting of many mega-cap tech giants.

As of Monday, 25% of the S&P 500 has reported Q1:2021 earnings. 84% of companies have beaten earnings expectations, with 77% beating revenue expectations. The average earnings beat has been 23.6% above expectations – FactSet notes that this level of average beat would be a record going back to 2008 if maintained.

At the start of the year, the street analyst consensus expected $168 / share in 2021 S&P 500 aggregate earnings. The consensus estimate has risen to $180 / share now, or 7% higher. These revisions account for just over half of the S&P 500’s 11% year-to-date (YTD) gain.

This quarter has marked a return to normalcy in terms of the market’s reaction to earnings. Companies that beat estimates on both revenues and earnings are up an average of about 1.5%, in line with historical averages. Companies that miss on both revenues and earnings are down over 2%, also in line with historical averages. This type of behavior contrasts with the fourth quarter of 2020 when all equities seemed to rise regardless of earnings.

Factor valuation update: value/dividend paying stocks remain cheap relative to their historical averages. Growth/momentum stocks have both cheapened somewhat relative to their historical averages. However, growth stocks remain expensive. In general, valuation is not a useful short-term market timing tool.

Fixed Income Takeaways:

Treasuries opened slightly lower on Monday, leading to a slightly steeper curve. Several tenors of Treasuries will be auctioned this week.

In major rating agency action, there have been over 600 corporate credit upgrades in 2021 YTD. Upgrades are outpacing downgrades by a factor of about 3:2.

Spreads were slightly tighter last week, reflecting continued mutual fund inflows into both investment-grade (IG) and high-yield corporate debt, as well as improving fundamentals for corporations.

The Federal Reserve (Fed) will meet this Tuesday and Wednesday, with the statement release and ensuing press conference on Wednesday. Market participants will likely be focused on the specific language used in the Fed’s press release, as well as comments from Fed Chairman Powell during Wednesday’s press conference.

The Fed remains committed to outcome-based guidance (maximum employment). Key Private Bank thinks it is unlikely that there will be any tapering of bond purchases (or any other significant Fed policy changes) announced this week.

General Takeaways:

The Federal Reserve (Fed) continues to project a near-zero fed funds rate until 2024. An increasing number of market participants are beginning to doubt this forecast. One prominent bank CEO recently noted that if the recent increase in inflation proves to be long-lasting, it may force the Fed’s hand into raising rates earlier than expected.

Indeed, the Bank of Canada recently announced that they would begin tapering their current quantitative easing program due to strength in the Canadian economy. These moves pushed Canadian yields higher and strengthened the Canadian dollar.

COVID-19 update: many emerging markets, such as India, continue to experience a worsening outbreak of the disease. The suspension of certain vaccines is only exacerbating these public health concerns.

Initial unemployment claims for the week ending 4/17/21 came in at 547,000, a bit lower than expected—this number crested above 6 million last year. The recovery in the job market remains uneven, but steady progress continues to be made.

Could the recent economic data be the best we will see during this cycle? The Conference Board’s Leading Economic Index (LEI) rose a strong 1.3% in March. Goldman Sachs predicts that the peak in US GDP growth for this cycle will occur in the second quarter of 2021.

Due to strong recent stock market performance, future returns will likely be more muted and more volatile. Since 1980, the average intra-year calendar drawdown has been about 14%. In other words, drawdowns of more than 10% are not unusual during most calendar years.

Equity Takeaways:

After stumbling about 1% on Thursday, stocks rose in early trading on Friday. The S&P rose 0.50%, with small caps up about 1%.

On Thursday, stocks fell due to the specter of higher capital gains taxes. The Biden Administration plans on increasing long-term capital gains taxes to over 40% (including the 3.8% Medicare surcharge) for a select group of the highest-earning taxpayers.

Going back to 1968, there has been essentially zero correlation between changes in the capital gains rate and market returns during that same calendar year. In the very short term, the stock market is a bit extended due to its strong recent performance. The capital gains tax news could be the catalyst that touches off a bit of profit-taking.

In addition to the tax reform news referenced above, the Biden administration is also modifying its plan to control drug prices. This news is positive for the health care sector, especially the biotech sector, which showed strong relative performance yesterday.

About 75% of reporting companies have beaten earnings estimates, with a similar number beating estimates on revenue. The sectors with the strongest earnings (energy, materials, and financials) are showing poor relative performance after reporting. The implication is that much of the good news in these cyclical sectors has already been priced in.

Environmentally and socially conscious (ESG) investing continues to gain steam. 2020 was a record year for ESG fund flows, and over 90% of CEOs say that they will be shifting more resources into this space.

Also, the strong recent performance of many ESG funds has debunked many previous concerns about lagging returns. Strong due diligence is required in this space to avoid “greenwashing,” but we think ESG investing will continue to grow further.

Fixed Income Takeaways:

Emerging market spreads vs. Treasuries have dropped significantly since the 2020 trough, indicating increased risk appetite in the credit markets. In addition, BB-rated securities now comprise a larger portion of credit indices when compared to historical averages, indicating that the credit quality of major bond indexes is likely a bit lower than average.

After a sharp move higher in Treasury rates in the first quarter, the 10-yr note yield has settled into a range over the past few weeks. The 10-year note currently yields approximately 1.53%.

Overseas yield comparisons: German 10-year note: -0.28%, Japanese 10-year note: 0.07%; UK 10-year note: 0.72%. Many foreign investors continue to look towards the US market for better relative value compared to their home markets. This dynamic remains a tailwind for US Treasuries.

As more companies emerge from earnings season, we expect new issuance in the investment-grade (IG) corporate bond market to pick up in the coming weeks. Generally, companies cannot issue new debt in their earnings blackout periods.

The high-yield bond market also continues to see robust new issuance, with some new borrowers tapping the current easy credit conditions. A strong economic and demand backdrop continues to support spreads.

In the 1-5yr municipal bond space, yield ratios to Treasuries are about 45%. Typically, ratios in this area of the curve are about 75%.

Low yield ratios continue to indicate that municipal bonds are very expensive relative to Treasuries.

Any change in fund flows or more clarity around potential tax law changes could trigger a selloff in municipals. We saw a similar dynamic in late February.

General Takeaways:

Despite record highs in the stock market, there are some causes for concern:

• - COVID – still lots of unknowns and lots of risks.
• - Rising taxes and regulation.
• - Domestic social unrest and inequality.
• - Geopolitical tensions in many places.
• - Budget deficits expanding.
• - Inflation acceleration – transitory or long-term?
• - Bubbles are inflating.

On the other side of the coin, it appears that in the current environment, the positives likely outweigh the negatives:

• + COVID – vaccinations are happening (although unevenly).
• + COVID – hospitals not stressed and are far better prepared.
• + Economies are reopening.
• + Monetary stimulus – massive.
• + Fiscal stimulus – massive.
• + Inventories being rebuilt; capital spending and hiring both picking up.
• + Consumers’ balance sheets fortified (positively impacting both stock prices and home prices).
• + Banks’ balance sheets also fortified (deposit growth and benign credit).

On the COVID-19 front, this week could see total global vaccine doses administered reach one billion, an amazing feat for global ingenuity. As we noted last week, in the US, the supply of vaccines is no longer an issue. In the US, demand is now the limiting factor for vaccine uptake, especially in the South and Midwest.

That said, according to a recent survey from the Kaiser Family Foundation, sentiment towards vaccines is slowly improving, especially among respondents in the “wait and see” camp. As more data is released, the general comfort level around COVID-19 vaccinations seems to be increasing. However, the percentage of respondents who say they will not take the vaccine has remained relatively constant.

As the economy reopens, we may see a reversal of fortune among certain sectors. Sectors that benefited from the pandemic, such as health care, technology, grocery stores, autos, and furniture, could now face headwinds due to tough comparisons and slowing demand. On the other side of the coin, sectors such as restaurants, recreation services, and air travel are due for a rebound.

Consensus GDP estimates for the second quarter are now up to 10.2% year-over-year growth. It remains to be seen whether this strong GDP growth will translate into wage growth. Sustained wage growth could have a significant impact on long-term inflation.

Equity Takeaways:

Stocks opened slightly lower in early trading on Monday. The S&P 500 dropped about 0.15%. Small caps dipped about 0.50%.

About 9% of the S&P 500 has already reported first-quarter 2021 earnings, with the pace set to rise significantly over the next two weeks. To this point, 81% of S&P 500 companies have beaten earnings expectations, which is a substantially higher percentage than the long-term average. Financials look especially strong, with the average stock in this group topping earnings by over 38%.

Thus far, the companies that have reported have beaten bottom-line expectations by 30.3%, which would be a post-2008 record. Revenue surprises are also at record levels, with 84% of reporting companies exceeding revenue expectations. Strong revenue numbers indicate that it’s not just cost-cutting allowing companies to deliver these strong results.

If corporate earnings continue to surprise to the upside, the stock market will have a significant tailwind. We remain constructive on equities in this strong earnings environment.

Hedge fund net exposure (longs minus shorts) is at about 66%, which is in the 100th percentile over the last ten years. In other words, on aggregate, hedge funds are currently more bullish on stocks than they have been over the previous ten years.

Fixed Income Takeaways:

Since the beginning of April, the 10-year Treasury yield has dropped about 15 basis points (bps). Strong recent Treasury auctions and renewed demand from overseas buyers and pension funds have contributed to the recent strength in bonds.

Most bond market participants still believe that longer-term Treasury yields will likely move higher as we go through the year. As long as the move higher in yields is orderly and does not happen too quickly, we don’t believe higher yields will destabilize the markets.

New investment-grade (IG) corporate bond issuance tends to slow down during earnings season. This year, substantial recent issuance out of financial companies for regulatory reasons has bolstered overall activity.

High-yield debt new issuance is on pace for its busiest month ever. Another $15 billion of high-yield debt priced last week as investors search for yield.

General Takeaways:

Despite recent concerns around COVID-19 vaccines from AstraZeneca and J&J, vaccine supply in the US is no longer the limiting factor in the expanding rollout. According to Axios, demand for vaccines is now the primary concern, especially in the South and Midwest, and possibly a reflection of some people’s hesitancy over vaccines in general.

The geopolitical concerns of the day include new US sanctions on Russia over cyberattacks/election meddling and continued rising tensions between China and the US.

Iran and Israel also continue to spar over the former’s nuclear program. Such tensions have yet to rattle markets but should be monitored nonetheless.

Headline initial unemployment claims fell more than expected this week, dropping 193,000 to 576,000. Continuing claims also continue to grind lower. Claims remain elevated relative to pre-pandemic levels, but the labor market is showing good progress.

As unemployment claims have begun to moderate, retail sales have exploded. Retail sales jumped 9.8% in March (vs. consensus of 5.8%). Strength was broad-based, with sporting goods, apparel, motor vehicles & parts, and restaurants all showing double-digit gains in sales.

The strengthening economy is also resulting in higher inflation, but the numbers over the short term must be examined in the context of a significant base effect. Inflation fell significantly during the spring 2020 shutdowns. Thus, year-over-year inflation comparisons may be a bit misleading for the next few months.

A key for future inflation will be wage growth. Many small businesses now report that certain jobs are hard to fill, and NFIB US Small Business survey data indicates a tightening labor market.

Evercore ISI survey data corroborates the NFIB data – companies generally expect wage inflation over the next 12 months. Also, Evercore ISI data indicates that most companies think inventory levels are too low, which could further trigger inflationary pressures. We will continue to watch the data for clues on inflation as we move into the summer months.

Equity Takeaways:

Stocks were flat to slightly higher in early Friday trading. The S&P 500 rose about 0.2%, while the Nasdaq dropped a similar amount. Small caps rose about 0.4%.

The S&P 500 closed at another all-time high yesterday after a strong session that saw the index rise over 1%. After a period of consolidation in mid-February through March, the index broke decisively above 4,000 in early April and has been steadily rising for the past several weeks.

Recent relative strength has been concentrated in the largest companies. The recent drop in Treasury yields could be supporting large caps vs. small caps. Small caps appear to be consolidating after very strong gains since the third quarter of 2020.

Gold miner equities have shown strength over the past several weeks. Shares in gold miners tend to lead the price of the metal itself by about two weeks.

Developed international markets are also making all-time highs, although recent performance has lagged the US. Commodity-linked stocks are showing good relative strength as the global economy reflates. European economies should also benefit from the recent US stimulus.

Emerging markets continue to struggle, with India experiencing a COVID-19 surge. Chinese equities also continue to lag after a very strong relative performance in 2020.

Fixed Income Takeaways:

Federal Reserve (Fed) Chairman Powell spoke again this week and reiterated that any changes in Fed policy would have a long lead time. The Fed plans to telegraph any tightening in policy by tapering bond purchases well before raising rates.

US Treasuries have found their footing. The 10-year Treasury yield approached 1.75% several weeks ago but has dropped close to 1.50% during this week’s trading. Recent strength can partially be explained by renewed interest from global investors and pension fund buying.

Despite this recent strength, the bulk of market participants continue to expect higher yields on 10-year Treasury rates over the intermediate-term.

Year-to-date supply in the investment-grade (IG) corporate bond market stands at about $517 billion, a drop of about 21% from 2020’s elevated levels. Spreads continue to show resilience and are approaching all-time lows in both the IG and high-yield markets.

Spreads remain supported by positive mutual fund flows, as well as a contracting supply dynamic. If supply remains under control, we believe spreads have room to tighten further.

Municipal bond yields continue to fall. Municipal bonds are rich across the curve, with a 10-year high-quality municipal yielding approximately 60% of the 10-year Treasury. Typically, a 10-year municipal bond will yield about 95% of the comparable Treasury note.

Over $2.4 billion of new funds poured into municipal bond funds over the past week, explaining the tightening in spreads.

General Takeaways:

COVID-19 is not going away quietly. Both the Johnson & Johnson and AstraZeneca vaccines are under review for possible blood clotting issues. Also, it is unknown how the spread of variants will affect those who have already been vaccinated.

The good news: in the United States, more than 3 million vaccine doses are being administered daily. It will take only another three months to vaccinate 75% of the US population at this pace.

The bad news: globally, the pace of vaccine adoption is much slower due to an uneven rollout. Poorer countries are being disproportionately affected.

As we’ve been noting for many months now, both fiscal and monetary stimulus remain at historically high levels. These funds are supporting the private sector, where US domestic consumer activity is surging. Corporate balance sheets have also been bolstered, leading to higher CEO confidence.

Federal Reserve (Fed) Chairman Jerome Powell was on 60 Minutes last night to discuss the Fed’s outlook for the economy and continued stimulus. Powell presented a generally bullish outlook and reiterated that the Fed has no plans to raise rates in 2021.

Over the near term, the Fed expects the economy to strengthen. Inflation is likely to move above the Fed’s long-term target of 2%, but this event alone will not be enough to trigger a rate hike. Powell stated that the Fed does not plan on raising rates until the labor market is back to maximum employment, and inflation is on track to move above 2% for “some time.”

Powell’s comments on 60 Minutes generally mirrored recent Fed talking points. The Fed is now providing “outcome-based guidance” and is looking for “substantial further progress” in the economy. The Fed plans to leave accommodative policies in place until achieving its goals.

Debate on President Biden’s new infrastructure plan is just beginning, with many influential senators and representatives staking out their initial positioning. It will likely take months of negotiating before a final compromise is reached.

Equity Takeaways:

Stocks dipped slightly in early trading on Monday. The S&P 500 dropped about 0.15%, while the Nasdaq dropped about 0.7%. Small caps were also slightly lower, down 0.3%.

Last week was one of the strongest weeks for the S&P 500 since the November 2020 presidential election week. The S&P 500 rose 2.75% for its third consecutive week of gains. Technology shares led the market, with the Nasdaq rising almost 4%. Small caps lagged, dipping 0.4% on the week.

Underlying stock market breadth is confirming the move higher. 76% of stocks advanced last week, which brought the cumulative advance/decline line to an all-time high. This type of price action is positive on a technical basis.

Going back to the second quarter of 2020, equity analysts have consistently underestimated corporate earnings power. In other words, most earnings surprises have been to the upside since the 2020 trough. The first quarter 2021 earnings season is set to begin in earnest this week, and we expect continued strength.

One possible risk to the outlook is supply shortages across various industries. Shortages in semiconductors and lubricants are two notable examples. We expect input price increases to be passed through to consumers eventually.

Fixed Income Takeaways:

The 10-year Treasury yield has settled into a range between 1.60% and 1.75%, last trading at 1.66% on Monday morning.

According to a recent ISI survey, about 90% of respondents expect the next 25 basis point move in the 10-year Treasury yield to be higher. This week, this sentiment will be tested, as the US Treasury will be auctioning several different tenors of Treasuries.

Corporate spreads continue to contract. CCC-rated debt, the riskiest segment of the market, now trades with an option-adjusted spread of 632 basis points (bps), its lowest level since before the Great Financial Crisis of 2008. BBB-rated bond spreads have also contracted significantly, and at 117 bps, are also approaching all-time lows.

Borrowers continue to take advantage of these historically low spreads. We expect a large amount of activity over the next few weeks, as many companies will announce new debt deals in conjunction with earnings reports.

General Takeaways:

Key Private Bank’s health care analyst recently met with the leadership of a large vaccine maker. Some general color on their progress is below.

This company is currently applying for full FDA approval for their COVID-19 vaccine. In 2021, the company expects to deliver 300M doses of their vaccine in the US alone. After some initial difficulties, the rollout is proceeding smoothly, especially in the US.

The company is concluding trials in various booster shots to combat additional COVID-19 variants. The company is studying various methods to combat these variants, including a cocktail of vaccines. We should expect additional news on this front over the summer.

National digital currencies would facilitate much faster cross-border currency transactions. China is the first mover in the digital currency space, which uses blockchain technology at its core. China’s newest 5-year plan stresses self-sufficiency/research & development of new technologies.

China recently announced that their goal is to become carbon-neutral by 2060. Chinese and European leaders are combining to determine a framework for environmentally sustainable technologies/initiatives.

Equity Takeaways:

US stocks were essentially flat in early Friday trading. The S&P 500 rose about 0.10%, while small caps dipped about 0.3%. Over the past five sessions before Friday, the S&P 500 was up 3.2%.

Over the past week, technology shares have rediscovered some of their lost luster. The Nasdaq has been rising about 5% over the past five sessions. The outperformance of cyclicals was significant in the fourth quarter of 2020 and continued into the first quarter of 2021, so it’s not surprising to see some level of mean reversion within the underlying market leadership. The recent stabilization of long-term treasury yields has also provided some near-term support to technology shares.

First Quarter 2021 earnings season is set to begin soon. Expectations for earnings growth are high. As we’ve stated in the past, continued earnings growth will be necessary for the stock market to continue its strong performance in 2021.

International shares also had a nice week, led by the United Kingdom and Australia. The STOXX 600 (a broad European index) closed at an all-time high yesterday, highlighting the strength of global equities.

One notable exception remains Asia, where Chinese shares continued their recent underperformance. Chinese shares outperformed much of 2020 but have run into headwinds as the rest of the world has begun to reopen.

Fixed Income Takeaways:

The 10-year Treasury note has traded in a tight range this week, with yields oscillating between 1.62% and 1.70%. With front-end yields pegged near 0% by the Federal Reserve (Fed), the 2-year / 10-year curve remains steep, at about 150 basis points (bps).

The Fed released minutes from their March meeting. They expect that inflation will increase in mid-2021 before normalizing in 2022. They remain committed to outcome-based guidance – in other words, the Fed is in no rush to remove stimulus, preferring to wait for continued improvement in the labor market.

In public comments yesterday, Fed Chairman Powell reiterated plans for ongoing stimulus. In general, recent messaging from the Fed has been consistently dovish.

High-yield spreads continue to grind tighter and are only 2 basis points from their 14-year low of 290 bps. Yesterday, high-yield borrowers raised about $7 billion, which is the busiest day for high-yield issuance in about two months.

Within the investment-grade (IG) market, supply remains robust, although off the highest issuance levels of last year. About $25 billion of new supply is expected to hit the market next week.

The story is similar within the municipal bond market. Yields continue to grind tighter. Municipal bond funds continue to see strong inflows, a tailwind for the asset class for most of 2021.

Expectations for future tax increases to fund Biden’s infrastructure plan remain one factor driving additional interest in municipal bonds. With the narrow margin in the Senate, future compromise on the underlying components of the plan seems likely.

General Takeaways:

We have received lots of questions regarding Bitcoin, so we thought we’d cover it briefly here. The price of Bitcoin (BTC) continues to rise. BTC is one of over 1,200 decentralized cryptocurrencies. It is often described as “digital gold,” but it is unclear if BTC can serve as a storer of value due to its high volatility.

BTC is also akin to fine art in many ways – value is in the eye of the beholder with no fundamental framework for the value of the asset.

Another similarity with gold - Bitcoin has also served as a medium of exchange, but both asset classes have limitations in that regard. There is also significant uncertainty concerning the regulation of BTC and other crypto assets.

In general, the blockchain technology that underpins Bitcoin and other cryptocurrencies is extremely promising. From an investment perspective, specialized managers with domain expertise in the technology ecosystem may be the most effective way to access this space.

Key Private Bank continues to research all aspects of blockchain and cryptocurrency, and we will have more to say on these topics in the coming weeks.

COVID-19 cases have once again begun to inflect higher, and we are starting to hear increased chatter of a fourth global wave. That said, mobility continues to increase in the US as the vaccination supply expands.

Non-farm payrolls were reported last Friday, and the data was impressive. Including revisions, just under 1 million jobs were added last month. The US unemployment rate last checked in at about 6%. If the current pace of job gains continues for the next nine months and assuming some partial recovery in the labor force participation rate, the unemployment rate could drop to 3.5% by the end of this year.

Despite these strong headline numbers, the healing in the labor market has been uneven. Certain sectors, such as leisure and hospitality, remain depressed. The Federal Reserve (Fed) is likely looking at this dispersion underneath the surface of the headline data to help inform their forward outlook. Put another way, the Fed is unlikely to raise rates until the labor market's recovery broadens out.

Equity Takeaways:

Stocks opened higher on Monday in response to Friday’s strong employment data. The S&P 500 and Nasdaq both rose close to 1% in early trading. Small caps rose about 0.25%.

The book is closed on the first quarter of 2021. Global equity returns were strong, while fixed income had a tough quarter. Global equities rose 4.8%, while global bonds dropped 5.3%. US equities rose 6.4% during the quarter, while the global ex-US index rose about 3%.

Within the US, equity returns were paced by small caps, which rose over 12% during the quarter. US large caps rose 5.9%. Value stocks significantly outperformed growth stocks, with energy and financials the two strongest sectors.

Given that the economy continues to reopen, we expect cyclicals to continue their strong relative performance as we head into the second quarter. Technology shares continue to trade more akin to defensives.

Shares in high quality companies have significantly underperformed shares in low quality companies over the past several months. Low quality companies tend to be more economically sensitive than high quality companies – low quality tends to outperform coming out of cycle troughs as a result.

In general, we continue to believe that high quality companies outperform low quality companies over a full cycle.

Fixed Income Takeaways:

Treasuries are selling off slightly after Friday’s strong jobs report. The treasury curve continues to steepen, with the 10-year note currently trading around 1.73%.

In the first quarter, the selloff in Treasuries led to a 3.4% loss for the US taxable bond index.

Supported by fiscal stimulus, municipal bonds fared better, dropping about 0.4% in the first quarter.

Given the sharp rise in rates in the first quarter, it would not surprise us if treasury yields remain in their current range for some time. That said, we expect 10-year treasury rates to drift towards 2% as we go through the year.

Last week had a “risk on” tone. Investment-grade (IG) spreads tightened by 6 basis points on the week and are now back to post-COVID tights. High-yield spreads tightened by 18 basis points last week, a significant move.

Within IG debt, new issuance volumes remain robust but are down about 9% year-over-year compared to last year’s record levels. In general, a greater share of new deal proceeds are being used for acquisition financing, as the environment for mergers and acquisitions has become increasingly robust.

General Takeaways:

COVID-19 cases remain well off the peak levels we saw over the winter but nevertheless have inflected higher over the past week. Hospitalizations have also begun to tick higher.

That said, the US is currently administering about 2.5 million vaccinations per day, and business optimism is returning. Expectations around both retail sales and future employment have turned decidedly positive.

Highlighting a point that we made in our Friday commentary, the next phase in President Biden’s fiscal stimulus plan will revolve around infrastructure. The plan has two portions: “traditional” infrastructure as well as “human” infrastructure.

Traditional infrastructure investment would upgrade the nation’s aging railroads, public transit, utilities, pipelines, and water transportation. This portion of the bill also includes investments in climate infrastructure, housing, schools, and expanded broadband.

Human infrastructure investments would include expanded paid leave, an extension of the Child Tax Credit (CTC), national child care, universal pre-K, and free community college.

On a related note, the Suez Canal situation highlights the fragility of global supply chains, along with the lack of global infrastructure investment over the past several decades. Commodity prices are ramping up in expectation of increased capital expenditures, but it will take years to improve the global supply situation.

Stretched supply chains will only exacerbate inflation expectations, which continue to tick higher.

We see price pressures in both goods and services. Recent purchasing manager index (PMI) data indicates sharp increases in output prices over the past several months. That said, upward pressure on wages remains muted.

Equity markets will be closed this Friday in observance of the Good Friday holiday. Non-farm payrolls will be released on Friday, and market participants are expecting very strong job growth.

Equity Takeaways:

US stocks opened mixed on Monday. Large caps dropped by about 0.25%, while small caps rose about 0.50%.

Last week, a hedge fund was sent into forced liquidation, which caused wild trading in certain Asian technology stocks as well as certain US communication services companies. It is not clear whether this liquidation is complete– this uncertainty could put some pressure on the market early this week.

In a reversal of recent trends, large cap stocks significantly outperformed small caps last week. Large caps rose almost 3%, while small caps fell nearly 2%. Even so, small caps have risen more than 12% year-to-date (YTD). The S&P 500 is up about 6.2% YTD, while the Barclays Aggregate bond index is down about 3.3% over the same timeframe.

Since mid-January, some of the frothiest technology stocks have begun to underperform vs. “quality” technology companies. Indeed, many investors suffered losses in certain high-profile speculative trading stocks, call option volumes are declining, and “spec-tech” euphoria may be losing steam.

In general, Key Private Bank continues to promote a quality bias with respect to individual stock selection. Quality companies tend to underperform low-quality companies coming out of a cycle trough but should outperform over a full cycle.

Fixed Income Takeaways:

Treasuries are rallying Monday morning in response to the hedge fund liquidation news referenced above. The 10-year Treasury yield remains between 1.60% and 1.70%, recently trading around 1.65%.

Despite turbulence in the stock market, credit spreads were well behaved last week, with both investment-grade (IG) and high-yield bond spreads tightening on Friday. In general, spreads were unchanged on the week.

Month-to-date, we’ve seen about $180 billion of IG corporate bond issuance, and we are poised to cross the $200 billion mark this week for total supply in March. Corporations continue to issue new debt at a furious pace.

Demand for short-dated commercial paper remains extremely strong. Yields continue to contract, and liquidity is strong.

General Takeaways:

President Biden’s infrastructure plan is beginning to take shape. The plan adds about $3.7 trillion in new spending, focusing on “traditional” infrastructure as well as “human” infrastructure. It also contemplates increased taxes of approximately $2.7 trillion over ten years, which loom as a potential future headwind to the stock market.

Traditional infrastructure investment would upgrade the nation’s aging railroads, public transit, utilities, pipelines, and water transportation. This portion of the bill also includes investments in climate infrastructure, housing, schools, and expanded broadband.

Human infrastructure investments would include expanded paid leave, an extension of the Child Tax Credit (CTC), national child care, universal pre-K, and free community college.

More details on the bill are likely next week. Actual legislation will likely be written over the August recess for September release. Most Republicans will likely oppose the bill.

The March US Markit Services Purchasing Manager Index (PMI) rose to 60.0%, its highest level since June 2014. In addition, the future output index jumped 72.7, to its highest level on record.

The continued improvement in the economy is driving unemployment claims lower. Initial claims were 684,000 for the week ending March 20th, the lowest reading since the March 2020 surge. Pandemic Unemployment Assistance Claims also fell.

The Suez Canal, a vital trade route, remains blocked by a large stranded vessel. Approximately 50 ships per day pass through the canal, accounting for as much as 12% of the world’s seaborne trade. Even before the blockage of the canal, supply constraints were already beginning to push consumer prices higher.

That said, even as near-term inflation expectations are rising, future inflation expectations are beginning to moderate. We may get a temporary spike of inflationary pressures, followed by a return to more normal levels. In fact, this scenario appears to be the Federal Reserve’s base case.

Equity Takeaways:

Stocks rose in early trading on Friday. Large caps rose about 0.5%, while small caps rose about 1.5%.

Yesterday, a weak auction of 7-year notes caused a midday blip higher in Treasury yields, which ignited a rally in cyclical assets. Small caps, financials, industrials, and materials all outperformed the broader market on Thursday.

Over the week prior to yesterday, the relative outperformance of cyclical assets had seemingly stalled. We will continue to monitor the dynamics underneath the surface of the market closely.

International markets bounced back on Friday after a tough week. Chinese equities rose over 2%, while Japanese equities rose over 1%.

European stocks continue to remain under pressure from shutdowns tied to COVID-19.

Fixed Income Takeaways:

Treasuries have begun to settle into a range. After hitting yields as high as 1.75% last week, the 10-year Treasury note yield has stabilized in a range between 1.60% and 1.70%.

Federal Reserve (Fed) speakers continue to present a dovish picture on interest rates. This guidance has been supportive of the front-end of the curve, where yields remain very low. Overall, the Treasury curve remains steep.

We see predictions of 2.00% to 2.25% for the 10-year Treasury yield by the end of 2021. An orderly move higher in yields would likely signal a strong economy - a bullish sign for equities. That said, if the move in yields is disorderly, markets would likely face headwinds.

Corporate bond issuance continues to be supported by the Fed. Investment-grade (IG) corporate bond issuance continues apace, and high-yield spreads have stabilized along with treasuries.

The municipal bond market also continues to trade well. Year-to-date (YTD), the asset class has seen over $30 billion of cumulative inflows, despite the low level of absolute rates.

As we discussed in a recent Key Questions article, the direct aid to state and local governments provided in Biden’s COVID-19 bill has been a significant tailwind to municipal bonds over the past month. Direct municipal support is being received very favorably by investors, driving spreads tighter and yields lower.

General Takeaways:

Vaccinations continue to rise. COVID-19 vaccine makers are expected to produce 132 million doses this month, nearly triple last month’s pace.

On aggregate, over 22% of the broad US population has received at least one dose, but over 2/3 of the 65+ population has received at least one dose. In response, nursing home deaths are down almost 90% from peak levels.

Both anecdotal and company survey data indicate that a surge of pent-up demand is hitting the economy.

Evercore ISI retailer sales survey data hit an all-time high last week, and airports are having their busiest days since March 2020.

The reopening remains uneven. Florida restaurant dining has almost fully recovered, while dining in California is still over 40% below the peak, and activity in New York is more than 70% below the peak.

The US Federal Reserve (Fed) has responded to this bump in activity by increasing its forecasts for growth and inflation. That said, the Fed did not increase their expectations for future interest rates, which, as we noted last week, is a clear change in the Fed’s long-term reaction function.

As we wrote last Friday, the Fed would often pre-emptively tighten policy to control inflation in the past. Ever since the middle of 2020, the Fed has been consistent by stating that economic growth is their priority and that they will tolerate a transitory bout of inflation above their 2% long-term target.

Also, the Fed is very mindful of the uneven recovery in the labor market and wants to see total employment broaden out. Leisure and hospitality sector activity is still depressed, with total employment in that sector about 20% below the prior peak.

According to ISI, the current situation is unprecedented in recent history. We have never experienced a recovery from this type of pandemic recession. We have not seen this level of fiscal stimulus in a non-wartime environment. We have never seen the Fed use this type of policy framework.

Equity Takeaways:

US equity markets were mixed in early trading on Monday. The S&P 500 rose about 0.4%, while small caps fell a similar amount.

International markets were flat to slightly higher.

The S&P 500 index fell about 0.75% last week, not surprising given the strength off the March lows. The index is about 5% above its March 4 low and about 2.5% off its recent all-time high.

Large caps significantly outperformed small caps last week, reversing a recent trend. Since the March 2020 lows, relative weakness in small caps has been bought aggressively by market participants.

Part of the weakness in equities over the past week was driven by hedge fund selling. In aggregate, hedge funds remain bullish on the long-term outlook for equities and the economy, but on a short-term basis, hedge funds seem to have adopted a more defensive posture last week.

On Monday morning, two large railroads announced a merger, with the acquisition target being purchased at a 25% premium to its Friday closing price. The terms of this merger seem to indicate long-term confidence in the economic outlook by the acquiring party.

Compared to US equities, emerging market (EM) stocks have shown relative weakness in March.

Headline risk will always be a part of this sector (see recent news in Turkey and Iran), and recent strength in the US dollar has also contributed to recent EM weakness.

Fixed Income Takeaways:

The yield curve continued to steepen last week, with 10-year Treasury yields touching 1.75%. Monday morning, we saw a slight rally in Treasuries of 3-4 basis points (bps) in the intermediate and long-dated sections of the curve.

This week, Fed officials have more than 20 speaking engagements scheduled. Recently, Fed governors have generally projected a consistent message (low rates for longer) across their various speeches.

Both investment-grade (IG) and high-yield corporate credit continue to trade in an orderly fashion, despite a softer overall environment for spread products. High-yield spreads widened about 11 bps last week, while IG spreads were essentially flat.

Corporations continue to issue new debt aggressively. The high-yield corporate bond market has already seen its second-busiest quarter on record for total issuance, and we still have almost two weeks remaining until the end of March.

General Takeaways:

US and Chinese officials met today in Alaska. The initial tone of the conference was tense suggesting tensions between the world’s two largest economies persist. July 2021 marks the 100th anniversary of the communist party in China, so we expect public rhetoric to remain strained over the next several months as China attempts to project a strong image.

According to Deutsche Bank, the US is making faster progress in COVID-19 vaccinations than the rest of the world. Vaccine attitudes are improving globally, and the US and Europe could hit 70-80% herd immunity thresholds by late summer.

Congress has turned its attention to the next round of planned fiscal stimulus, this time focusing on infrastructure. Biden administration priorities include transportation, green energy, improved efficiency, expanded broadband access, and tax incentives. This plan will likely be funded in part by increased taxes.

The US Federal Reserve (Fed) significantly increased growth expectations for 2021. Their projection for 2021 US GDP growth is now 6.5%, versus projections for 4.2% growth as recently as December. Expectations for inflation in 2021 were also increased. This is a significant shift in a short three-month period.

Despite ratcheting up predictions for growth and inflation, and reducing their projection for future unemployment, the Fed did not change its projections for future interest rates.

In effect, the Fed has changed its reaction function. In the past, the Fed would often pre-emptively tighten policy to control inflation. Ever since the middle of 2020, the Fed has been consistent by stating that economic growth is their priority, and that they will tolerate a transitory bout of inflation above their 2% long-term target.

In addition, the Fed is very cognizant of the uneven recovery in the labor market and wants to see total employment broaden out. Leisure and hospitality sector activity is still depressed, with total employment in that sector about 20% below the prior peak.

Equity Takeaways:

US markets were mixed in early trading on Friday. The tech-heavy Nasdaq rose slightly in early trading, while the S&P 500 dropped about 0.5%. Small caps also fell about 0.5%.

Today’s stabilization in technology stocks follows a sharp selloff yesterday that saw the sector fall about 3%. This drop was caused by another sharp rise in Treasury yields. Technology shares tend to be disproportionately affected by rising yields due to the long-dated nature of their future expected cashflows.

The spike in Treasury yields is causing a major rotation within the equity markets. Over the past several months, financials, which benefit from a steeper yield curve, have significantly outperformed the broader market. That trend continued yesterday, with financials the only major S&P sector in the green.

Significant funds have begun to flow into value ETFs as investors have begun to reposition their portfolios towards financials and cyclicals. On a short-term trading basis, value ETFs have gotten a bit extended relative to the broader market.

Fixed Income Takeaways:

The past week was a very busy one in the fixed income markets. The Fed increased core PCE estimates for 4Q:2021 to 2.2%, above their 2% long-term target for inflation. The core PCE is the Fed’s preferred gauge of inflation. Essentially, the Fed has baked in an overshoot on inflation into current policy estimates.

During his press conference, Fed Chairman Powell was steadfast. According to Powell, the Fed has no plans to raise rates anytime soon in reaction to higher Treasury yields and believes much of the higher inflation projected for 2021 will be transitory.

Initially after Powell’s Wednesday press conference, short and intermediate-term yields dropped. On Thursday, yields across the curve reversed higher, with the 10yr hitting 1.70%.

The Fed did not announce any actions on Yield Curve Control (YCC), which disappointed some market participants. The Fed is not concerned about the absolute level of long-term rates, and in some ways, the market is doing the Fed’s job by raising long-term rates.

With the choppiness in yields, much of the planned supply in the new-issue investment-grade (IG) corporate bond market was delayed this week. That said, IG spreads have remained stable even as yields have drifted higher.

Conversely, high-yield bond prices continue to show moderate weakness. Year-to-date returns in the asset class are now slightly negative after another 5 basis points of spread widening yesterday.

General Takeaways:

Progress continues concerning the rollout of COVID-19 vaccines. Over 107 million doses have been administered in the United States. Overall, the US accounts for about 1/3 of total worldwide vaccine doses administered.

Germany, France, and Italy suspended the use of AstraZeneca’s COVID-19 vaccine. This act could be a short-term headwind for European markets.

Significant global economic stimulus continues. Evercore ISI data notes that some lagging sectors (airlines, restaurants) appear to be inflecting higher. The purchase of the Extended Stay hotel brand dovetails with this improving data.

ISI has also observed that US bank total loans have risen for the past four weeks. Bank loans had been declining throughout the crisis.

Moreover, the recent increase in US Consumer Net Worth is estimated to rise 20% year-over-year (YOY) in the first quarter of 2021 or $1.3 trillion unprecedented and provides significant purchasing power.

Finally, there is debate over debts and deficits. Some observers note that high government deficits go hand in hand with high personal savings rates and increased corporate profits. Government spending during the crisis supported corporate profits and allowed corporate balance sheets to remain stable. Modern Monetary Theory (MMT) can help explain this dynamic.

Equity Takeaways:

The stock market has been focused on the impact of continued stimulus on corporate earnings – earnings growth should be a significant tailwind for the market and, at least to this point, has outweighed expectations for higher future taxes.

Fixed Income Takeaways:

Bond investors will be hanging on every word during this week’s Federal Reserve (Fed) meeting. Any updates to the Fed’s future interest rate projections, or expectations for future inflation, could have a significant market impact.

Key Private Bank expects that interest rates will likely continue to drift higher, all else equal.

General Takeaways:

Stimulus, Stimulus, Stimulus. In 2021 dollars, the 2020-2021 “CARES” fiscal stimulus has hit approximately $5 trillion, or 23% of GDP. This program compares with $1 trillion for the 2009 Recovery Act, which was about 6% of GDP.

The last time the US saw non-wartime fiscal stimulus on this order of magnitude was the 1933-1939 New Deal, which at $780 billion accounted for 40% of GDP.

One result has been a jump in the US Personal Saving Rate, which has spiked to multi-year highs.

Much of this increased savings has flowed into the markets and is having a direct impact on stock prices. Other coincident indicators, such as the EVRISI Trucking Survey, are also spiking to multi-year highs after massive falls in 2020.

Positive momentum is building in the job market as well. The US unemployment rate, which approached 15% in 2020, has dropped to 6.2%. Some forecasters are predicting a drop in unemployment back below 4% as early as 2022.

Despite an increasingly strong economic outlook in the United States, central banks around the world (including the US Federal Reserve) continue to provide abundant liquidity. For example, yesterday, the European Central Bank (ECB) announced an increase in monthly bond purchases to help control borrowing costs. The ECB will also further tap into an emergency $1.8 trillion pandemic liquidity program.

Recent party initiatives out of China include:

• Increased digitization (including a digital currency).
• Less reliance on the US for technology.
• An increased maritime presence.

China currently has the largest Navy in the world.

Pfizer released updated vaccine efficacy data yesterday, which showed extremely promising results from their studies in Israel. According to CNBC, Pfizer’s vaccine was at least 97% effective against symptomatic COVID-19 cases while blocking 94% of asymptomatic cases.

Equity Takeaways:

US markets were mixed in early trading on Friday. The tech-heavy Nasdaq fell about 1.5% in response to rising bond yields. The S&P 500 fell about 0.25%, while small caps rose a similar amount. Cyclical sectors, such as financials, industrials, and energy, continued their recent pattern of outperformance.

Year-to-date (YTD) performance divergences continue. The large cap Russell 1000 growth index is essentially flat for the year, while the Russell 1000 value index is up about 10% YTD.

Within smaller companies, the Russell 2000 growth index is up more than 11% YTD, while the Russell 2000 value index is up by more than 27% YTD. These divergences highlight the difficulties tech stocks have faced in 2021 after strong outperformance in 2020.

On the international front, developed market stocks outperformed emerging markets this week, with Chinese equities under pressure. YTD, the China Shanghai Composite is down about 1%, while the FTSE developed ex-US benchmark is up 4.5%, and the FTSE emerging market benchmark is up 6.6%.

Fund flows for stocks have turned decidedly positive, with more than $30 billion flowing into the asset class this week. Conversely, flows for both bonds and gold were negative over the past week.

Fixed Income Takeaways:

Treasuries are under pressure once again this morning after waves of selling in the futures market during the Asian session. The 10-year Treasury yield has reached 1.60%, close to the highest year-to-date print of 1.62%.

We expect continued fiscal stimulus to pressure yields higher. Corporations seem to feel the same, as they are rushing to issue new debt before rates rise further. Through Thursday, over $50 billion of new investment-grade (IG) deals had priced on the week.

Overall, the tone in the credit markets remains firm, with high-quality deals still receiving strong demand despite the rise in treasury yields. IG corporate bond funds saw over $3 billion of inflows last week.

Conversely, high-yield bond funds saw $5.3 billion in outflows, their largest weekly cash outflow since July and the fifth largest on record. This asset class has performed well recently, so these flows could simply be profit-taking.

During the second half of February, municipal bonds came under pressure, but the weakness was short-lived. Beginning March 1st, municipal bond yields began dropping again, even in the face of rising treasury yields. Municipal bonds are once again expensive relative to treasuries, especially in the 5-10-year part of the curve.

Investors are reacting to the large amount of direct aid to state and local governments included in the recent federal fiscal stimulus bill. $350 billion of assistance will go to state and local governments, with more than $150 billion of aid to schools.

This type of federal support provides a large safety net for municipalities and should cover lost revenue from 2020. Municipal bond spreads are tightening as a result.

General Takeaways:

Over the weekend, Iranian-backed Houthi rebels targeted a key point of Saudi Arabian oil infrastructure, while Microsoft endured a massive cyberattack. Brent crude prices spiked over $70 / barrel over the weekend in response to the rebel attack, but prices have since reversed and are now below Friday’s trading levels.

Despite these reminders that the world will always remain an uncertain and volatile place, there is plenty of good news to celebrate as well. Significant progress is being made on the vaccination front, and COVID-19 case growth has materially slowed. According to USA Today, cases of COVID-19 within nursing homes are down 89% and the number of Americans vaccinated now exceeds the number of people who have contracted the virus.

The expectation is for this positive momentum to continue. President Biden recently commented that the US should have enough supply to vaccinate all adults by the end of May. This timeline is significantly ahead of the expectations of just a month ago.

In response, states around the country are beginning to reopen further. The Dallas Fed economic mobility index (MEI) is designed to correlate with current activity. This indicator spiked up last week to levels last seen in March 2020, indicating that more and more Americans are comfortable being out and about.

The Senate officially passed President Biden’s “American Rescue Plan” over the weekend. This plan amounts to more than $1.9 trillion and is the first phase of Biden’s “Rescue and Recovery” plan. The package funds additional direct payments to households, expands unemployment insurance, and provides significant aid for state and local governments, education, health care, and small businesses.

Later this year, we expect additional fiscal stimulus to the tune of over $1.5 trillion, primarily targeted towards long-term investments in infrastructure, clean energy, healthcare, social safety net programs, and business competitiveness.

The Federal Reserve (Fed) also continues to provide significant monetary stimulus to the economy.

The Fed’s internal projections estimate that their initial rate hike will occur in 2024. Market expectations for interest rate hikes project the first hike in 2023, about a full year earlier than the Fed’s internal estimates.

Equity Takeaways:

Last week, despite weakness in some more prominent names, we saw about 70% of the issues in the S&P 500 trade higher on the week. Weakness was concentrated in larger technology names. Energy, financials, industrials, and materials all continued to show strong relative strength.

Over the past several weeks, we have seen a quick and violent rotation away from growth/momentum stocks into value / cyclical stocks. Momentum stocks have underperformed the broader market by over 10% during this timeframe.

Despite the recent rotation, value stocks are still very cheap compared to the broader market on a Price/Earnings basis, and growth stocks have enjoyed years of outperformance relative to value stocks. We will continue to closely monitor the relative performance of growth vs. value to inform our broader asset allocation recommendations.

Fixed Income Takeaways:

As of March 5th, major fixed income regulators made the final decision to fully retire the London Interbank Offered Rate (LIBOR). The phaseout of many tenors will conclude by the end of 2021. The more common 1-month, 3-month, and 6-month tenors will remain in use into 2022-23. Provisions will be made to produce a synthetic LIBOR rate used to accommodate existing issues with maturities in 2023 and beyond.

The 10-year US Treasury yield continues to climb and is now moving towards 1.60%, with a strong jobs report on Friday adding fuel to the fire. Strong economic growth and additional fiscal stimulus are two factors that could continue to put pressure on treasuries as we move into 2021.

In sympathy with rising Treasury yields, investment-grade (IG) corporate bond spreads were wider by 4 basis points (bps) on Friday and 6 bps on the week. High-yield corporate spreads were about 9 bps wider last week.

It has been quite some time since we saw this level of widening in the IG market.

Last week, despite widening spreads, it was a busy one for new IG corporate bond issuance, with over $65 billion of deals pricing. We are expecting another $40-$45 billion of new issuance this week.

Corporations continue to anticipate rising rates and are quickly moving to issue new debt as a result.

General Takeaways:

Despite recent volatility, global equities rose 2.6% in February. US equities rose 3.1%, while global ex-US equities rose about 1.9%.

Conversely, global bonds fell about 1.3% in February and are now down 1.9% year-to-date (YTD). US taxable bonds are down about 2.2% YTD, while US municipals are down about 1% YTD.

Underneath the surface of the stock market, we saw significant divergences in performance by sector and style. Small companies outperformed large companies, while value outperformed growth.

Cyclicals significantly outperformed the broader market.

Energy was the best sector, up over 22% in February and over 27% YTD. Financials were next, up more than 11% on the month and 9% YTD.

Previous leadership has stagnated, with technology shares essentially flat YTD.

On a 1-year trailing basis (February to February), global equities are up about 23%. US equities are up 24.5% during this timeframe, with non-US developed market equities up 13.6%. Non-US emerging market equities (including Chinese shares) are up 28.4% during this timeframe.

According to the Wall St Journal, COVID-19 vaccines are yielding breakthroughs in the long-term fight against infectious diseases. Gene-based technology has many possible uses in the years to come.

COVID-19 case growth inflected higher once again last week. Mobility data is also beginning to improve, suggesting that more people are “out and about” as spring begins to arrive.

More fiscal stimulus is on the way from the federal government. The $1.9 trillion COVID-19 relief bill is currently moving through Congress, with a mid-March approval seemingly on track. Among many things, this bill includes additional direct household stimulus, flexible state and local aid, and the extension of unemployment insurance through September 30th.

Equity Takeaways:

US stocks opened sharply higher on Monday. Both the S&P 500 and Nasdaq rose approximately 1.5% in early trading. Small caps rose close to 2%. International shares also generally rose between 1-2%.

Over the weekend, news that Australia's central bank is expanding bond purchases seemed to spark equity market futures. The signal that central banks are once again ready to step in with asset purchases seemed to calm nervous sentiment.

Quote from strategist Jim Bianco (Bianco Research) over the weekend: “when central bankers panic, you don’t have to.” The implication is that increased central bank asset purchases are generally positive for equity markets.

The momentum index made an all-time high in mid-February but has fallen about 10% since. As noted above, the past month saw a dramatic rotation towards cyclicals at the expense of momentum-driven areas of the market (growth, etc.).

On a related note, the broad S&P 500 hit an all-time high of 3950 on February 16th but traded very choppily towards the end of February as long-term interest rates rose sharply. The index was trading at 3880 in early trading this morning, so we are still just a few percentage points from an all-time high.

Fixed Income Takeaways:

In February, US Treasuries posted their biggest monthly loss in four years. Yields are drifting higher once again this morning after a short-lived rally towards the end of last week.

The Federal Reserve (Fed) is likely more concerned about rising short-term rates than rising long-term rates. Last week, certain measures of market interest rates were pricing in rate hikes as soon as the third quarter of 2022. This market behavior contrasts with recent commentary from the Fed and will likely draw Fed governors' attention if it persists.

In corporate bonds, recent trading has been orderly despite the uncertainty generated by rising rates.

Friday was a busy day for new issuance, with some borrowers likely pulling forward new deals in anticipation of higher rates.

The high-yield bond index hit an all-time low yield of about 3.90% in February. Recently, yields on high-yield bonds had risen towards 4.25%.

Despite rising longer-dated yields, the yields on very short assets (commercial paper, T-bills, etc.) are approaching negative territory due to several technical factors in the market. We think this dynamic should clear up by the second half of the year.

General Takeaways:

An economic boom appears to be materializing. Forecasts for 2021 GDP growth continue to increase. The official average estimate is about 4.9%, but we have seen some estimates as high as 8%.

Industrial production, retail sales, and personal savings have all recovered sharply over the past twelve months. Certain measures of economic activity, such as the US ISM supplier deliveries and ISM backlog of orders indices, indicate further possible inflationary pressures.

In anticipation of this economic boom and amidst rising inflation expectations, Treasury bond yields rose sharply yesterday. As we’ve been discussing over the past several months, a rising rate environment has significant implications for many different asset classes. We continue to believe that real assets can provide significant portfolio diversification in this type of environment.

Commercial real estate prices have stabilized amidst the recent economic recovery. Early anecdotal reports around the recent Texas cold snap indicate that most of the damage in the area was minor. Real estate is one type of asset class that can provide income while protecting against inflation.

Equity Takeaways:

US stocks opened flat to slightly higher this morning after selling off sharply yesterday. International shares are generally lower today in sympathy with yesterday’s weakness in the US.

During yesterday’s selloff, growth stocks were down about 3.1%, while value stocks dropped just shy of 2%. Decliners outnumbered advancers by a factor of 7:1.

The S&P 500 is down just over 2% on the week, with the Nasdaq down over 5%. A change is afoot underneath the surface. Even after yesterday’s selloff, the energy sector was up more than 8% over the past five sessions, with financials and industrials each up 2% over that timeframe. Rotation towards cyclicals appears to be picking up steam.

Large growth stocks with very strong earnings in 2020 will begin running into tough year-over-year comparisons as we move through 2021. The top 6 stocks in the S&P 500 all have a growth/technology slant and still account for about 23% of that index's total market capitalization.

Earnings season is winding down and has seen companies broadly beat estimates. The highest beat rate has been in the energy patch, with the average company beating estimates by more than 50% in that sector.

Implied volatility (VIX) spiked to almost 30 yesterday. This morning, the VIX is slightly lower at 28.1 in early trading. The VIX has remained elevated relative to pre-COVID levels throughout the past year.

Fixed Income Takeaways:

Yields spiked sharply higher yesterday. The yield on the 5-year Treasury note jumped 20 basis points (bps) to about 0.80%, while the yield on the 10-year note jumped 13 basis points to close over 1.50%. The 20 bps jump in yields is the largest one-day move in the 5-year note since 2013.

Despite the higher yields, high-yield bond spreads narrowed by 5 bps yesterday, suggesting that the selloff is not likely to become a mass contagion event.

Earlier in the week, Federal Reserve (Fed) Chairman Jay Powell suggested that the Fed will continue to wait on raising rates. Powell noted that the economy is a long way from its long-term goals, with some estimates still pegging unemployment as high as 10%.

With Powell’s comments underpinning short-duration treasuries, the 2-year and 10-year Treasury curve continues to steepen. At 140 bps, this curve is now at its steepest level in five years. Going forward, the Fed could implement Yield Curve Control (YCC) by extending the duration of their Treasury purchase program to control longer-dated yields.

The investment-grade (IG) bond index is down about 3.2% year-to-date (YTD), yet fund flows remain positive in this asset class. High-yield bonds continue to see small outflows.

Due to their floating-rate nature and short duration, leveraged loans are beginning to see interest once again, with the asset class seeing substantial inflows last week.

In the past five days, municipal bonds have cheapened significantly to treasuries. Additional new issue supply, slowing mutual fund flows, and arbitrage selling contributed to the pressure on municipals.

Municipal bonds move in sympathy with treasuries, but the asset classes do not move in lockstep. With municipal bond demand seeming to dry up this week, we will be watching closely for signs of stabilization in the coming weeks.

General Takeaways:

COVID-19 trends are moving in the right direction. Daily new cases, hospitalizations, and fatalities are all falling. Vaccinations are being administered to the tune of more than 1.6 million doses per day. About 16% of US adults have received at least one dose, with more than 6% having received two doses.

In addition, recent data out of Israel indicates that the Pfizer COVID-19 vaccine has high efficacy and could also help prevent the virus's asymptomatic spread. A reduction in the spread from asymptomatic carriers would be a significant positive.

We can also see positive sentiment in the boardroom, where US CEO confidence recently hit a 15+ year high. This data bodes well for both future job growth and capital expenditures.

According to a recent survey at ISI, investors are becoming less worried about COVID-19, and more worried about possible tax increases and/or a less favorable regulatory environment. Rising inflation is also supplanting COVID-19 as a top concern, an issue we foreshadowed in our 2021 Outlook.

Treasury Secretary Janet Yellen gave a roadmap for the new $1.9T COVID-19 relief bill, which is on track to pass Congress by mid-March. COVID-19 relief will come first, followed by infrastructure spending. Yellen did imply that higher taxes are likely to be slowly implemented as well.

Bitcoin can best be viewed as a speculative asset, comparable to digital gold or perhaps high-priced art. Bitcoin has significantly more volatility than gold. Increased institutional adoption of bitcoin is a tailwind for future usage. For greater insights into our thinking regarding Bitcoin, please refer back to the January edition of our Key Investment Perspectives.

Equity Takeaways:

US stocks opened lower this morning. The S&P 500 fell 0.5% in early trading, with the tech-heavy Nasdaq down over 1%. Small caps were flat.

The market has had a nice run recently and is pulling back a bit off the top end of a rising trend channel. A consolidation/pullback towards the lower end of this trend channel would not be surprising. This pattern has been in place for several months.

Also, investors seem to be becoming more worried about rising interest rates/inflation. A faster, more substantial recovery, driven by stimulus, could spark pockets of inflation, which could trigger a change in stock market leadership. Indeed, the economy's manufacturing sector has recovered strongly and is even seeing some supply constraints, while the services sector has lagged.

Small caps, energy, financials, materials, and industrials continue to show notable outperformance versus the rest of the S&P 500, highlighting this potential change in leadership. This outperformance reflects a rotation towards economically sensitive cyclical sectors that we have been discussing for several months now.

Fixed Income Takeaways:

Treasury yields continue to rise. The 5-year / 30-year spread hit its steepest level in over five years. The 10-year Treasury yield touched 1.39% before pulling back to its recent level of 1.34%.

Despite this rise in yields, the Federal Reserve (Fed) remains focused on full employment for all American workers. On Friday, NY Fed president Williams told CNBC that he is not concerned about the recent increase in yields.

Williams’ comments are consistent with the notion that the Fed is more focused on the composition of the move in yields and the drivers of that move, rather than just the 10-year yield itself.

The selloff in longer-dated debt has now spilled over into the corporate bond market. Longer-term corporate bonds have come under pressure, and corporate bond new issuance has slowed down over the past few weeks in sympathy with rising yields.

We expect investment-grade (IG) new issuance to pick up strongly this week – we will be watching carefully to see how this supply is absorbed in a rising rate environment.

Last week, municipal bond yields rose for the first time in many weeks. Two-year municipal yields rose 4 basis points (bps) on the week, while 5-30-year municipal yields rose 15-18 basis points.

Sentiment in the new issue municipal bond market also weakened in sympathy with rising yields. This weakening is forcing dealers to cut prices/increase yields to attract demand.

The new $1.9 trillion federal fiscal stimulus bill contains about $350B in additional state and local aid. We expect a vote in the House as early as the end of this week, with final passage in the Senate anticipated in mid-March.

General Takeaways:

Massive global stimulus continues. For example, the size of the balance sheet of the US Federal Reserve (Fed) is up 80% year-over-year. The size of the European Central Bank’s balance sheet is up a similar percentage.

This stimulus has manifested itself in several ways – higher stock prices, rising inflation expectations, higher home prices, and higher energy/commodity prices.

The recent strong price action in various markets begs the question – are we currently in a bubble, and if so, what would cause that bubble to pop? Bubbles are very hard to identify in real-time. However, one common theme over the years is that bubbles typically burst when financial conditions are tightening. We explore this topic in greater detail in this week's edition of Key Questions, titled, "What Causes Bubbles to Burst."

As noted above, financial conditions are currently very accommodative, and the personal savings rate is increasing. When financial conditions tighten, the Treasury yield curve tends to invert. Recently, the yield curve has steepened, with long-term rates rising as short-term rates remain stable. These moves in rates are not indicative of tightening financial conditions.

Many areas of the economy continue to perform well, with US real retail sales, industrial production, and house prices showing considerable strength since the mid-2020 trough. The hospitality and leisure segment remains under extreme pressure, however.

With daily new COVID-19 cases continuing to fall, it seems reasonable to expect mobility trends to improve once the weather thaws. However, recent events in Texas will likely have a ripple effect throughout the US economy for the next several months.

Equity Takeaways:

US stocks opened higher this morning, bolstered by positive overnight economic news on the international front. The S&P 500 rose about 0.3% in early trading, with small caps up about 1%.

Rising interest rates seemed to weigh on investors’ minds this week, as the market chopped sideways to lower over the past several days. Over the last five trading sessions through Thursday, the S&P 500 was essentially flat, with small caps down between 1-2%.

The S&P 500 has been rising in a trend channel over the past four months. Investors seem to be hedging more when the S&P 500 reaches the top end of this channel and vice versa.

Earnings season is beginning to wrap up. As we’ve noted on recent calls, results have generally beaten expectations, but the market reaction has been muted. As long as earnings continue to improve, the S&P 500 should have a strong tailwind despite modestly rising interest rates.

The strength in Asia, especially Japan and China, is driving recent international stock markets. Conversely, European shares have been weak as the region has struggled with ongoing COVID-19 outbreaks.

Fixed Income Takeaways:

Long-term interest rates continue to inch higher. The 10-year Treasury yield began the week at 1.21% and recently moved above 1.30%. The curve's front-end remains pegged at a very low level, with the 2-year Treasury yielding about 0.11%.

The Federal Reserve (Fed) does not seem overly concerned with this recent move higher in rates. Multiple Fed members have stressed recently that the Fed remains focused on weakness in employment.

The rising rate environment has crimped new issue supply in the investment-grade (IG) corporate bond market. That said, new deals continue to be very well received. This week, the typical order book was about 5x oversubscribed, which is well above average.

IG corporate bond funds continue to see significant inflows – investors seem to have an insatiable appetite for credit funds even as rates have begun to rise. High-yield bond funds, which have performed very well recently, saw slight outflows.

Municipal bonds have continued to richen vs. treasuries and other types of fixed income over the last six weeks. Money continues to pour into municipal bond funds, and supply is down almost 20% year-over-year, leading to a supply-demand mismatch.

On Wednesday and Thursday, we finally saw a move higher in long-term municipal bond rates, with yields rising about 15 basis points (bps) across the two sessions. The tone in the municipal bond market on Friday morning is soft, extending the past few sessions' weakness.

Even after the move higher in yields of the past several days, municipal bonds remain expensive relative to treasuries.

General Takeaways:

In a recent speech, Federal Reserve Chairman Jay Powell said that the employment picture is "a long way" from where it needs to be. Powell noted that the actual unemployment rate is probably closer to 10% and said that the Fed needs to stay focused on its "broad and inclusive" employment goal.

Powell’s comments underscore the fact that the Federal Reserve (Fed) is nowhere close to pivoting on policy, despite increasing optimism about the growth outlook associated with vaccinations and fiscal support. Massive, unprecedented fiscal and monetary stimulus will continue throughout 2021.

A big question for the coming year is whether the continued stimulus will stoke increased inflation. Market expectations for inflation in the back half of 2021 are rising, but actual Consumer Price Index (CPI) readings remain moderate.

Mobility trends have remained muted over the past several weeks, even as COVID-19 cases have dropped significantly. As the weather warms up and vaccinations continue, it seems reasonable to expect mobility to increase, which would be positive for the economy in general.

Equity Takeaways:

With most Asian stock markets closed today for their lunar new year holiday, US equities opened flat to slightly lower on Friday morning. International shares were also essentially flat.

Over the prior five trading sessions, the S&P rose about 1.2%, with small caps up about 4.5% during that period. On a year-to-date basis, the S&P 500 is up about 4.5% through Thursday, while small caps are up close to 16%, reflecting continued optimism about economic recovery through 2021.

Many investors are worried about an imminent stock market top. For comparative purposes, at the end of the 1990s bull market (March 2000), earnings growth was rolling over, the price/earnings ratio of the market was over 30x, and the Fed Funds Rate was 6%. The Fed would tighten rates further, to 6.50%, even after stocks peaked.

In contrast with March 2000, earnings growth remains strong, and both fiscal and monetary policy remains remarkably accommodative. As long as earnings growth continues and credit conditions remain favorable, the stock market will have a strong tailwind.

Coming into the 4th quarter of 2020, aggregate S&P 500 earnings were expected to decline by about 8%. With nearly 80% of companies reporting, actual performance has been much better than expected, with earnings growth in the 2-3% range.

As we’ve noted over the past few weeks, market reaction to earnings has been muted. Companies that beat their 2020 4th quarter estimates are not being rewarded as much as usual, while companies that missed 4Q estimates are not being punished as much as expected.

Fixed Income Takeaways:

The treasury curve continues to steepen. The 2-year treasury note yield hit an all-time low of 0.09% several days ago, while the 10-year treasury bond yield hit a post-COVID high of 1.19% on the same day.

The corporate bond new issue calendar was relatively quiet this week. That said, investment-grade (IG) spreads remain stable at their recent level of 92 basis points (bps) relative to treasuries. IG fund flows remain positive, and investors are favoring BBB-rated paper relative to single-A rated paper.

As measured by a widely followed index, high-yield bond yields fell below 4.00% for the first time this week. Even as yields fell, high-yield mutual funds saw slight outflows last week.

The weakest portion of the high-yield index (CCC-rated paper) continues to see increased demand and currently trades with a spread of 550 bps. The all-time low spread for CCC-rated paper is 510 bps.

Italian 10-year bonds yielded over 2% several months ago – they now yield 0.45%.

These examples of declining yields are all linked. Bond market participants across the globe are betting on continued monetary support, as well as low-to-moderate inflation.

The story remains the same in the municipal bond market. Money continues to pour into the sector, and with light-to-moderate supply expected, spreads will likely remain tight over the near-term as investors chase a limited supply of bonds.

General Takeaways:

News sentiment towards the COVID-19 vaccine has declined significantly over the past month. Expectations for the vaccine are currently low. If optimism around the vaccine begins to increase once again, we could see another tailwind for the economy.

Reported new daily COVID-19 cases are down 19% in the past week and 48% since peaking last month. Hospitalizations are down 15% in the past week and about 33% since the peak. Fatalities typically lag cases by about three weeks and appear to be in the process of peaking.

According to a study from the Brown University School of Health, about 75,000 people have been vaccinated in COVID-19 trials. Out of those 75,000 trial participants, none have died from COVID-19, which seems to indicate that the various vaccines have high efficacy against the virus.

Several factions seem to be brewing within the Democratic party itself surrounding the ultimate size of the next stimulus package. Prominent economist Larry Summers is concerned that another large-scale fiscal package could touch off significant inflation. On the other hand, Biden administration officials, such as Treasury Secretary Janet Yellen, are pushing for large additional fiscal stimulus. The Biden Administration has suggested that additional stimulus should be enacted by mid-March, but based on these rising tensions, this deadline could prove optimistic.

Meanwhile, reflective of Summers’ comments, inflation expectations have risen over the past several weeks and long-term interest rates have begun to follow suit. Higher interest rates would not necessarily be negative for stocks, however, quick, sharp moves higher in rates have historically been a headwind for the stock market.

Equity Takeaways:

US stocks rose on Monday morning. The S&P 500 was about 0.5% higher, with small caps up about 1.5%. International stocks also traded fractionally higher.

Markets across the globe are acting as if they expect continued economic recovery throughout 2021. Risky assets, such as stocks and commodities, continue to perform well. The technical picture remains favorable.

Last week, the S&P 500 rose over 4%, made an all-time high, and rose each of the five trading sessions. Since 2010, the market has risen over 4% in a single week on 16 different occasions. The market was higher the subsequent week on 10 of those occasions, however, the average move was slightly lower.

After such a sharp move higher, we expect some backing and filling to allow time for investors to digest the recent stock market strength.

4Q:2020 earnings season is nearing a close and was generally positive. Earnings estimates for 2021 continue to increase. If this trend continues, increasing earnings estimates will be a strong tailwind for equities in 2021.

Fixed Income Takeaways:

Treasuries remain under pressure, with long-term interest rates continuing to move higher. The 30yr treasury yield recently exceeded 2% for this first time in also a year. The 10yr yield is currently about 1.19% and has moved higher for eight consecutive trading sessions.

Midweek auctions of treasury securities could give us another clue into investor sentiment surrounding interest rates and inflation.

As treasury rates rose last week, demand for corporate bonds has remained strong. Spreads tightened in both investment-grade (IG) and high-yield credit last week.

As we’ve noted over the past several weeks, municipal bonds remain rich across the curve. Absolute municipal bond yields are approaching the all-time lows last seen in August 2020.

Out of the approximate $9B of municipal bond supply expected this week, almost $4B is expected to be taxable issuance. This type of dynamic makes it difficult to find supply in true tax-exempt paper, driving overall spreads tighter.

General Takeaways:

Despite high current valuations and bubble-like behavior in certain areas of the stock market, vaccine adoption progress will likely drive the broader market over the coming months. If the reopening of the economy is faster-than-expected, the stock market should benefit, especially cyclical sectors that are more leveraged to a reopening.

The last few weeks have brought progress on this front, with COVID-19 case growth falling as vaccinations steadily rise. Hospitalizations are also steadily decreasing.

On Tuesday, February 9th at 3 pm ET, Key Private Bank will be holding a special national client call with Dr. Stephen J. Thomas, MD. Dr. Thomas is the Chief of the Division of Infectious Diseases and Director of the Institute for Global Health and Translational Science at SUNY Upstate Medical University.

Dr. Thomas was directly involved in the development of the Pfizer COVID-19 vaccine.

Monthly non-farm payrolls were reported on Friday morning, and despite headline growth of 49,000, serious weakness persists in the hospitality and leisure sectors. The headline unemployment rate fell to 6.3%, led by strong job growth in business and professional services.

Despite continued progress in reducing unemployment, the labor participation rate fell once again, which implies some underlying weakness in the labor market that is likely not captured by the headline numbers.

Equity Takeaways:

The S&P 500 finished at another record high yesterday and is looking to finish up the best week since November. The S&P 500 was up about 4.2% on the week through Thursday, with the Nasdaq up over 5% during that timeframe.

This morning, the positive trend continued, with the S&P 500 rising another 0.3% in early trading. Small caps fared slightly better, rising 0.7%. International shares were also marginally higher.

The stock market seems to have shaken off the Reddit-driven volatility of last week, with several prominent brokerage firms reducing trading restrictions on Friday. Last week’s overall stock market correction was in the 4-5% range – we’ve seen several similar bouts of volatility since the March 2020 lows.

4Q:2020 earnings season is approaching a close, and it was a strong one, with over 80% of companies beating analyst estimates. That said, the market reaction to this good news has muted – it remains a "sell-the-news" quarter.

Many companies remain reluctant to provide full-year 2021 guidance given the uncertain forward outlook. Investors are rewarding companies that have been able to provide more clarity.

We continue to favor US stocks and non-US emerging market stocks vs. developed market international equities based on our internal asset allocation models.

Fixed Income Takeaways:

The 10-year treasury yield drifted higher throughout the week, beginning the week at 1.06% and rising to its current level of 1.18% on Friday morning.

With front-end treasury yields anchored by stable Federal Reserve policy, the yield curve continues to steepen as long-end yields rise. The yield difference between 5yr treasuries and longer-dated treasuries is at its widest level since 2015. A steepening yield curve is a positive for financial stocks, which have shown notable outperformance over the past week.

Within the new issue corporate bond market, we continue to see strong demand for environmentally and socially conscious (ESG) fixed income securities and strong demand for corporate bonds with a 20yr tenor.

Despite the selloff in treasury prices this week, municipal bond prices did not budge. As a result, the ratio of municipal bond yields to treasury yields has continued to compress. Within longer-dated securities, these ratios are at all-time lows, implying that certain municipal bonds are historically expensive relative to treasuries of similar duration.

Democrats are proposing another round of fiscal stimulus in the amount of approximately $1.9 trillion, while Republicans have countered with a plan about 1/3 the size. The Democratic proposal contains significant additional support for state and local governments, while the Republican plan includes no additional direct aid for municipalities.

General Takeaways:

Special Guest: Oscar Sloterbeck – Senior Managing Director, leader of Evercore ISI’s Company Surveys Team.

Daily new COVID-19 cases are down 36% in the US since peaking 17 days ago. The daily change in hospitalizations is down 21% from the peak, and the death rate also appears to be peaking.

Evercore ISI compiles weekly data from corporations to get a pulse on the economy. Over 350 companies in 29 different industries participate in Evercore’s surveys, which provide a real-time, bottom-up pulse on how the economy is doing. Survey data goes back to 1993.

The correlation between Evercore’s data and government-reported GDP growth and Purchasing Manager Index (PMI) data is solid. Current Evercore ISI Company Survey data is consistent with about 3-4% GDP growth for 2021. Evercore is projecting a strong 1H:2021 as the economy reopens.

Evercore ISI Company Surveys Diffusion Index: overall data did weaken in November and December as COVID-19 spread, but the data has strengthened again over the past month. Retailers and restaurants both showed improving sales in January.

On the other hand, Evercore’s consumer comfort index clearly weakened from mid-October to mid-January as the COVID-19 outbreak worsened.

In general, companies are reporting that the reopening and sales recovery is happening faster than expected, resulting in lower-than-normal inventories. Commercial real estate remains one area of notable weakness, along with airlines.

Equity Takeaways:

January 2021 was essentially a flat month for global equities. US stocks dropped -0.4% during the month, with global equities ex-US up 0.2%.

Within the US, small caps rose about 5% in January, while large caps dropped 1%. Overseas, emerging market stocks rose 3% on the month, while developed international stocks fell 1.1%.

January effect: going back to 1928, when January is positive, the full year is positive about 80% of the time. When January is negative, the whole year is positive a little less than 50% of the time.

"Retail favorite" stocks continue to power higher and have significantly outperformed the broader market since the March 2020 trough despite facing significant business challenges. Heavily shorted stocks have also outperformed considerably in recent days.

Implied volatility (VIX) has moved higher with the recent market volatility, with the VIX trading around 32.50 this morning. This indicator had settled into the low 20s throughout much of December and January.

Fixed Income Takeaways:

Key Private Bank has consistently noted the strong link between the corporate credit markets and the equity market, so continued strength in credit would be a favorable tailwind for equities as we go through 2021.

Inflation is a hot topic among Evercore’s customer base. Across many sectors, expectations of inflation and interest rates have increased, most notably within the real estate and industrial sectors.

As noted above, pressure on supply chains contributes to increasing inflationary pressures in the industrial sector.

General Takeaways:

As evidenced by the wild trading activity in certain individual stocks this week, markets have become more fragile. The conditions exist for isolated bubbles, something we profiled at the beginning of the week in our Key Questions article. Ultra-accommodative monetary policy, fiscal policy that has created an increase in disposable income, reduced trading frictions, and the rise of passive investing have all contributed to the current situation.

Overall, Key Private Bank believes the overall impact of this week’s activity should be limited, as the combined market capitalization of the stocks in focus represents a tiny portion of the overall market. Much of the activity has been concentrated in heavily shorted companies as well as those that are unprofitable.

One takeaway for the broader market is that coming into this week’s episode, overall sentiment was very stretched. Retail trading volume was spiking even before this week, and a low put-call ratio has also been indicating complacency.

Despite the headline volatility, credit markets have remained calm throughout the week, which is a positive signal in that we have not seen contagion into other asset classes.

On Tuesday, February 9th at 3 pm ET, Key Private Bank will be hosting a national client call with infectious diseases physician and Pfizer vaccine coordinating principal investigator, Dr. Stephen Thomas().

Equity Takeaways:

After a bit of a snapback rally yesterday, US large caps are opening about 1% lower this morning. Small caps, however, are slightly higher. Overall, it has been a tough week, with most major US indices falling about 2%.

The weakness has been especially pronounced in cyclical sectors like financials, materials, and energy. All of these sectors have dropped between 3-4% over the past five trading sessions. Defensives, such as consumer staples and utilities, are essentially flat over the same timeframe.

International markets have also had a tough week, with most major indices falling 2-4% – increased lockdowns have depressed estimates for near-term economic expansion.

Thus far, about 50% of the S&P 500 has reported 2020 4th quarter earnings, with about 80% beating street estimates. The reaction to earnings has been negative for the most part – it remains a "sell the news" earnings season. International markets have also seen similar activity, with investors more focused on the forward outlook.

The S&P 500 remains in an uptrend; however, this week’s price action has likely kicked off a consolidation phase that could take some time to work, though.

Fixed Income Takeaways:

This week’s Federal Reserve (Fed) meeting did not result in any major changes to policy. Fed Chairman Jerome Powell does not seem concerned about future inflation, characterizing any possible return of inflation as "transitory."

Rather than worrying about inflation, the Fed seems more concerned about the economic recovery falling short of expectations. The Fed is looking for a deep, broad, and sustained recovery to include as many of the country’s workers as possible.

Due to stock market volatility, the early portion of this week was quiet in the new issue investment-grade (IG) market. That said, as noted above, spreads have remained firm, and investors continue to pour money into the asset class.

The high-yield bond market tends to be more correlated with equities than the IG bond market – high-yield bond funds experienced outflows over the past week, but spreads have not widened much.

Municipal bond yield ratios relative to treasuries continue to drift lower (municipals continue to richen relative to treasuries). The asset class continues to experience a supply/demand mismatch, with strong investor demand chasing a small supply of bonds.

General Takeaways:

Merck announced they are discontinuing two COVID-19 vaccine candidates due to comparatively weak immune responses highlighting some of the complexities involved with vaccine development. Despite this setback, a cumulative 17.5 million total vaccine doses have already been administered in the United States.

On the positive front, the growth of COVID-19 cases and hospitalizations has inflected lower, and the data continues to improve. Cases are down 24% since peaking ten days ago, while hospitalizations are down 7% vs. a week ago.

At the same time, fiscal and monetary stimulus continues to flow through the economy, further bolstered by the bills passed in late 2020. A combined $11.3 trillion of fiscal and monetary stimulus has been injected into the US economy since February 2020 (over 52% of GDP). On a global basis, more than $29 trillion of stimulus has been injected during this timeframe (almost 34% of global GDP).

This stimulus reflects in the M2 money supply, which has surged more than $500 billion in the last two weeks alone (27% year/year). The M2 money supply includes cash and checking deposits, short-term bank time deposits, and certain money-market funds.

On a global basis, we’re seeing stimulus dollars impact a wide variety of markets. The US housing market remains extremely strong, while even the depressed oil & gas sector has seen its rig count inflect higher. Across the globe, 4Q Chinese retail sales surged 24% quarter/quarter to all-time highs.

Inflation expectations have also reacted to these massive stimulus programs, with one broad measure of inflation recently moving towards 2.2%, its highest reading in several years. In general, goods inflation is ticking higher, while services inflation remains muted.

One example of goods inflation: the "Input Prices" component of the US Markit Composite PMI recently spiked to its highest level in many years. This reading indicates that corporations are beginning to feel the impact of higher commodity prices.

Equity Takeaways:

US equities opened mixed this morning. Large caps opened about 0.4% higher, with small caps up about 1%. The technology sector continued its strong performance from last week, up over 1%, while cyclicals lagged, down about 0.5%.

Last week, the S&P 500 was higher for the third week out of four. Each of these gains was between 1.5% and 2%. Overall, the market remains pinned to the upper end of a trading channel, which is a positive technical pattern.

As we’ve noted recently, frothy investor behavior is on the rise. Trading in highly valued stocks with negative earnings has surged, margin debt continues to rise, and broad-market valuations are on the high side relative to history.

Despite these warning signs, the economic and interest rate backdrop is significantly different now than in 2000. Back in the late 1990s, the Federal Reserve (Fed) was in the process of raising interest rates to combat inflation. Today, the Fed policy remains very accommodative, interest rates are low, and corporate operating margins remain strong.

Key Private Bank continues to believe that a pause in the ongoing rally is possible to allow for time to work off some of the excesses listed above. Still, we continue to caution against becoming too bearish.

35% of the S&P 500 reports earnings this week, including many notable names. It has been a "sell the news" quarter – companies that have exceeded both revenue and earnings expectations have underperformed the broader market, which is very unusual.

Fixed Income Takeaways:

With a slight risk-off tone, treasury yields opened about 2-3 basis points (bps) lower on Monday. The 10-year yield was 1.06%, at the lower end of its recent channel.

The Fed meets again this week. Market participants are not expecting any dramatic policy changes and are likely to be reassured that no changes to forward guidance are imminent.

The US high-yield bond market has seen a banner month for new issuance. Currently, the high-yield market is about $1.2 billion shy of its busiest month for new issuance on record. We see similar activity in the municipal bond market as the thirst for yield continues.

AAA-rated municipal bonds remain very expensive on a historical basis relative to treasuries. Year-to-date, $11 billion has moved into the municipal bond market in the form of positive fund flows, while only $12-$13 billion of new deals have priced. Currently, there is not enough new issuance to soak up all the demand.

With the quest for yield, private core real estate / private credit funds look relatively attractive compared to certain areas of the fixed income markets.

General Takeaways:

This week, President Biden announced his new economic recovery plan, which comprises fiscal stimulus approximating 5% of GDP in 2021, remaining in place until 2025. Tax increases would then be implemented.

President Biden also released a comprehensive COVID-19 response plan that will hopefully continue the building momentum in the fight against the disease. Even before this plan, the pace of the vaccine rollout was increasing. Over 16 million Americans have received a COVID-19 vaccine, with almost 10 million vaccinations occurring in the last ten days alone.

Encouragingly, as vaccinations have increased, COVID-19 case growth is turning lower, with total daily hospitalizations also inflecting lower over the past several weeks. The improvement has been broad-based around the United States and the world.

Despite this positive news regarding COVID, economic data in the Eurozone has weakened over the last several months due to increased lockdowns. A double-dip recession in Europe is now possible, although analysts are also expecting a quick rebound as the vaccine rollout expands.

In the United States, the employment market remains stagnant, with over 900,000 workers filing initial unemployment claims last week. Despite this fact, the stock and housing markets' strength has bolstered overall consumer net worth to record levels. In many ways, the US situation remains a tale of two economies.

Equity Takeaways:

US stocks drifted lower Friday morning. The S&P 500 was down about 0.25%, with small caps down about 0.50%. Over the past several days, the tech-heavy Nasdaq has taken the lead, with more economically sensitive areas of the market pausing on a relative basis.

After several months of outperformance, cyclicals and small caps both underperformed large-cap growth stocks this week. Cyclicals and small caps would likely both be disproportionate beneficiaries of any sizeable fiscal stimulus package, so their relative performance could somewhat link to government policy over the next several months.

Despite mutual fund data showing negative flows into equities since 2018, significant positive flows continue into certain individual US stocks. As noted in the past, signs of complacency and even excessive optimism emerged in certain stock market areas over the past several months.

Due to this excessive optimism, a pause in the current rally would not surprise us. However, we would caution against becoming overly bearish. Instead, we would closely scrutinize current portfolio positioning and look to add additional sources of diversification.

The 2020 Fourth Quarter earnings season is off to a strong start, with over 90% of reporting companies beating earnings estimates and over 60% of companies beating revenue estimates. The reaction to earnings has been mixed, with investors much more focused on each company's forward outlook.

Year-to-date (YTD), developed international stock markets have outperformed the S&P 500 by about 0.80%, and emerging market equities have performed even better on a relative basis. The S&P 500 is up about 2.7% YTD, while developed ex-US markets are up 3.5% and emerging markets are up 8.8%.

Fixed Income Takeaways:

Despite rising inflation expectations, the Federal Reserve continues to signal a willingness to be ultra-patient with respect to rate increases. This stance continues to support risky assets as well as inflation expectations.

The 10-year treasury yield has traded in a tight range of 1.06% to 1.14% this week. As longer-dated yields have risen in response to increasing inflation expectations, the spread between 5-year and 30-year treasury yields has widened to about 140 basis points (bps).

The CCC-rated debt index recently hit an all-time low yield of about 6.42%. CCC-rated debt has rallied for 20 straight sessions and represents the riskiest portion of the high-yield debt market. Investors are clearly reaching for yield.

The investment-grade (IG) corporate bond market is also showing continued strength. New deal flow is solid, spreads are grinding tighter, and money continues to flow into the sector.

The story is similar in the municipal bond market. Despite expensive pricing relative to treasuries, investors continue to move funds into municipal bonds, perhaps anticipating increased federal aid from the Biden administration.

General Takeaways:

President Donald Trump was impeached for the second time this week, with 10 Republicans supporting the indictment. The charge is "incitement of insurrection." From the markets’ perspective, the move is being viewed as largely symbolic but could crowd the new administration’s agenda during the early days of Joe Biden’s presidency.

Recent COVID-19 trends are mixed. Deaths hit another recent high yesterday. However, net new hospitalizations have begun to decrease. Hopefully, increased vaccinations will lead to a sustained decline in hospitalizations, but there is some concern that cases remain elevated.

Progress on the vaccine front appears to be accelerating. As of Monday, roughly 6 million Americans had been vaccinated. By week’s end, that number increased to over 11 million.

Real-time economic data has cooled in response to the latest spike in COVID-19 cases but has not collapsed. The Dallas Federal Reserve collects information on mobility using anonymous cell phone data, and while the data has undoubtedly weakened over the last few months, it remains well above March-April 2020 levels.

The US Chamber of Commerce describes the current economic rebound as a "K-shaped" recovery, where certain companies exposed to digitization have benefitted from the pandemic. At the same time, other sectors, such as leisure and hospitality, remain under severe stress. Further reflective of this, the leisure and hospitality sector accounts for nearly half of post-COVID total job losses. On the other hand, other industries have suffered less, and some have even strengthened (i.e., e-commerce).

Inflation is beginning to pick up. The headline Consumer Price Index (CPI) rose 4% year/year, while US core personal consumption expenditures (PCE) data is approaching 2% year/year growth. The Federal Reserve (Fed) watches core PCE data closely.

Despite the recent higher readings on inflation, the Fed used cautious language this week to assure markets that no tightening of policy is imminent. The Fed seems more focused on weak economic growth in certain areas of the economy.

On the fiscal side, President-elect Biden released the details of his first proposed economic stimulus plan yesterday. Interestingly, the plan contains no tax hikes. Biden’s team signaled that a second plan is imminent, which will address infrastructure. Indeed, continued global stimulus should be a tailwind for both the economy and markets as we enter 2021.

Equity Takeaways:

Stock markets opened slightly lower in early trading on Friday. The S&P 500 dropped about 0.30%, with small caps down about 1.2%. The tech-heavy Nasdaq was marginally positive.

Investors could be "selling the news" of Biden’s new stimulus package and were possibly hoping for a slightly larger package overall. Retail sales were also weaker-than-expected this morning, which could be another contributor to this morning’s soft opening.

After much of 2020’s performance was driven by a narrow group of stocks, the recent rally has broadened out to include more sectors and styles. The increased relative performance of cyclical sectors and small caps indicates improved confidence in the economic outlook and is a healthy sign for the overall stock market.

Indeed, in 2020, the five largest components in the S&P 500 (all big tech names) delivered 63% of the total return of the entire index. These five large companies account for about 21% of the index’s market capitalization.

Fixed Income Takeaways:

The treasury yield curve continued to steepen for much of the week. Earlier this week, the treasury held auctions in both the 10-year and 30-year tenors, and both were met with strong demand.

As noted above, Fed Chairman Jerome Powell remains focused on the labor market and is not publicly worried about the recent pickup of inflation. We expect Fed policy to remain extremely accommodative in 2021.

Supply in the corporate bond market continues its strong pace, although we expect modest issuance on Friday due to the weak equity opening. The market's general dynamic remains unchanged, with spreads continuing to grind tighter in both investment-grade and high-yield paper.

The municipal bond market has a pronounced "January effect," where a large amount of cash usually enters the market due to December maturities and coupon payments. New issue supply is currently sparse, and reinvestment demand continues to drive spreads tighter.

The typical yield ratio for a high-quality 10-year municipal to the 10-year treasury is about 85-90%. The current ratio is about 71%, which is very low by historical standards, indicating that municipals are currently expensive relative to treasuries.

Biden’s proposed stimulus package includes $350 billion for state and local governments, $170 billion for colleges and schools, and $20 billion for mass transit.

General Takeaways:

COVID-19 cases spiked over the last week, with cases surpassing the pre-Christmas peak after a 1-week lull. The South and West continue to be the most significant hotspots, while case growth continues to decline in the Midwest. Hospitalizations also continue to increase steadily.

Despite the negative headlines surrounding the COVID-19 situation, the incoming Biden administration seems intent on releasing as many vaccine doses as possible. Moderna’s output capacity is increasing, as is public trust in vaccine safety. Progress will not be a straight line (see new restrictions in China). Hopefully, virus cases, hospitalizations, and deaths will begin to trend lower later this quarter as the vaccine rollout expands.

According to The Wall Street Journal (WSJ), job losses in 2020 were the worst since 1939. The leisure and hospitality sectors account for nearly half of the losses. That said, specific sectors such as construction are nearing full recovery.

As the economy recovers, the WSJ reports that 2021 could be the best year on record for job growth. The consensus forecast is for the unemployment rate to fall to 4.6% by December 2021, from its current level of 6.7%. The unemployment rate was under 4% before the crisis.

A tale of two economies has re-emerged, with college-educated workers aged 25+ showing an unemployment rate of only 3.8%, vs. 7.8% unemployment for workers aged 25+ with a high school degree. College-educated workers may have an easier time working from home.

Equity Takeaways:

The S&P 500 rose 1.9% last week and hit all-time highs on three separate trading days. It was a "risk on" week, with cyclical sectors such as energy and materials leading the advance. The Democratic victory in the Georgia Senate elections has investors pricing in additional fiscal stimulus, which should support the more economically sensitive sectors of the market.

The S&P 500 has moved towards the top of its rising trend channel, and sentiment remains frothy in certain areas of the market. A pause in the ongoing rally would not be a surprise.

The pause in the rally may have begun this morning, as the S&P 500 dropped about 0.75% in early trading, while the Nasdaq dropped about 1.25%. Defensive sectors, such as healthcare, consumer staples, and utilities, fared the best in early trading.

Retail investor activity in single stock options surged once again in November – December 2020. This type of activity is one sign of ebullient investor sentiment.

Fixed Income Takeaways:

Longer-dated treasury yields increased by 20 basis points (bps) last week. Both the 10-year and 30-year treasuries are trading at their highest yields since March 2020. The 5-year is also trading at its highest yield since June. The 30-year treasury bond last traded at 1.90%, with the 10-year at 1.13% and the 5-year at 0.49%.

Improved prospects for additional fiscal stimulus (and the resultant higher deficits/inflation) are driving longer-dated yields higher. The yield curve continues to steepen as a result.

Last week saw $55 billion of new investment-grade (IG) corporate bond supply. About $37 billion of those deals came from financial companies. As treasury yields have risen, investors continue to pour money into the asset class – spreads continue to tighten as a result.

Last week, municipal bonds outperformed treasuries. The ratio of AAA municipal yields to treasury yields in the 5-year, 10-year, and 30-year tenors is at a historic low (municipals are expensive relative to treasuries).

Municipals are in high demand, and in recent weeks, there has been a dearth of new issuance. This supply/demand imbalance has driven spreads tighter.

General Takeaways:

The 25th Amendment provides a framework for the transfer of power to the Vice President if the President of the United States is temporarily unable to fulfill his duties.

If the President is unable or unwilling to voluntarily transfer power, the vice president and a majority of Cabinet officials or "such other body as Congress may by law provide" could initiate proceedings on their own.

The chances of President Trump being removed by the 25th Amendment over the next few weeks seem slim, as do the prospects for another round of impeachment hearings.

The next Congress is set, but the margins are very narrow. With a narrow margin, Democrats can still control floor time and committee chairmanships, confirm Biden’s nominees and reverse Trump’s regulations. Democrats will have a tough time eliminating the filibuster and are thus unlikely to pass very progressive policies.

Main points of the Democratic agenda:

• Fiscal stimulus (direct payments to taxpayers)
• Infrastructure spending
• Drug pricing reform
• Expansion of the Affordable Care Act (ACA)
• Expansion of minimum wages
• Modest tax reform (likely via hikes on wealthy individuals and corporations)
• The expectation is for Monetary policy to stay very accommodative

The US employment situation is stalling– 140,000 jobs were shed in December (vs. expectations for a gain of 50,000), ending seven months of job growth. The unemployment rate is currently 6.7%. The leisure and hospitality sector remains under siege, shedding almost 500,000 jobs in December alone.

Chinese defense companies (and companies linked to them) are coming under scrutiny from US investors due to a recent US presidential executive order banning their purchase in the US. These events could increase volatility around Chinese companies in the future.

Equity Takeaways:

US equities briefly faltered after this morning’s weaker-than-expected employment report but recovered to open slightly higher. Both large and small cap US equities were up fractionally this morning. International stocks fared better and were generally 1.5% to 2% higher.

Small cap stocks have advanced in 8 out of the last nine weeks. In the last four trading days, small caps have risen 6% and have increased more than 30% over the previous six months. After such a strong short-term rally, a pause seems likely in this asset class.

Defensive industries, such as consumer staples and utilities, have lagged during the small cap rally. Expectations for strong earnings growth in 2021 are leading investors to look for more cyclical exposure.

Most of the strong stock price performance in 2020 was driven by P/E multiple expansion rather than earnings growth. We expect earnings growth to be the significant driver of stock price performance in 2021.

Fixed Income Takeaways:

Long-term treasury rates continue their slow move higher. The 10-year yield is currently trading around 1.09%, vs. 0.93% last week. The 30-year treasury yield is also moving higher, last trading at 1.86%. With short-term rates still anchored by the Federal Reserve, the curve continues to steepen.

The 10-year Treasury Inflation-Protected Security (TIPS) breakeven, a measure of expected inflation, also hit a recent interim high at 2.10%. TIPS are a form of US treasuries that investors can use to protect portfolios against higher-than-expected inflation.

The strong equity backdrop and improved fiscal stimulus prospects have continued to support heavy investment-grade (IG) corporate bond issuance. We had expected $40 billion of new issuance this week – through Thursday. We’d already seen $50 billion of deals hit the market.

Travel and leisure industry companies continue to price new deals despite continued severe pressure on their underlying businesses. This dichotomy highlights very easy existing financial conditions, where even stressed borrowers have access to the credit markets.

Short-term funding markets are also functioning well. Even with the recent political unrest, we saw very little stress in the commercial paper markets over the past week.

The recent Democratic victory in the Senate is likely a positive for municipal bonds, as the prospects for direct federal aid to state and local governments are higher under a Democratic regime.

Short-term municipal bonds remain expensive relative to treasuries. There is currently a lot of money chasing a limited bond supply.

General Takeaways:

The US death toll from COVID-19 surpassed 350,000 last week, the same day, nearly 300,000 new cases were reported – the highest number of cases reported for a single day in the US. A new, rapidly spreading variant of the virus is adding to the problem. Hospitalizations are also at a record level.

Slow vaccine rollouts have been an issue – as/of Saturday, January 2nd, only about 4.2 million Americans have been vaccinated, vs. initial goals of about 20 million by the end of December. Vaccination distribution needs to ramp up quickly.

It took ten months to reach 10 million total cases in the US, but less than two additional months to reach 20 million.

That said, case growth in the Midwest peaked in November and has inflected lower. Discouragingly, case growth in the West and South appear to be turning higher once again after a Christmas lull.

Elections in Georgia will determine control of the Senate tomorrow (Tuesday, January 5). If the Democrats win both open seats, the Senate will be split 50/50, and the Democrats will effectively gain control.

On the economic front, record amounts of both fiscal and monetary stimulus have bolstered stock prices and consumer balance sheets around the world. In the fourth quarter of 2020, global equities rose over 15%, while global bonds rose over 5%.

Equity Takeaways:

US equities opened flat to slightly higher this morning. Last week, the S&P 500 rose about 1.5%. Typically, a strong finish to December results in a positive early January.

While the calendar may have flipped, the drivers of the equity market remain the same. Credit conditions remain favorable, as do momentum and trend.

The two-year return of the S&P 500 (2019-2020) was more than 49%, the most substantial two-year return since 1998-1999. Historically, the market has risen at least 40% over a two-year period on 11 occasions. In the following year after these increases, 5 out of 11 years saw negative returns.

The fourth quarter saw dramatic divergences. For example, US small cap stocks rose over 31% during the fourth quarter alone, while US large caps rose about 12% during the same timeframe. Value sectors, such as energy and financials, also put in a strong performance in the fourth quarter but remained severe laggards for the full-year 2020.

The biggest question in the future is whether the fourth-quarter outperformance of value stocks and more economically sensitive sectors will continue. Stronger-than-expected economic growth and/or higher interest rates will tend to favor these areas of the market.

Implied volatility (VIX) continues to grind lower, with the VIX last trading around 24. Declining implied volatility is a short to intermediate-term tailwind for the market, as certain types of mechanical trading strategies tend to add equities as volatility declines.

Fixed Income Takeaways:

Investment grade (IG) corporate bond credit spreads have tightened back to pre-COVID levels, indicating that stress within the funding markets has mostly abated. High-yield bond spreads have also compressed significantly.

IG issuance is opening 2021 with a bang. We expect about $40 billion of issuance this week. In total, more than $1.7 trillion of IG corporate debt was issued in 2020, a record. For 2021, about $1.2 - $1.3 trillion of issuance is expected.

The yield curve steepened in 2020 as inflation expectations have risen. The yield curve's front-end is very sensitive to Fed rate policy, while the longer-end is more sensitive to inflation.

The recent federal fiscal stimulus package did not feature direct stimulus to state and local governments. However, municipalities will benefit indirectly, as $82 billion is earmarked for schools and $45 billion for public transportation.

The Federal Reserve’s $500 billion municipal credit facility expired on December 31, 2020. Only two borrowers tapped this facility, to the tune of $6 billion, so its direct effect on the markets was limited (although the facility certainly provided psychological support during a time of stress).

Municipal bond issuance is expected to be light this week as market participants await the Georgia Senate election results.