Key Private Bank Investment Brief

Key Takeaways:

Moody’s downgraded US government debt to Aa1 from Aaa. US government debt is now rated below Aaa (the highest possible rating) by all three major ratings agencies (Moody’s, S&P, Fitch).

According to the Wall Street Journal, Moody’s said, “… successive US administrations and Congress have failed to agree on measures to reverse the trend of large fiscal deficits and growing interest costs …”

In the past, markets have shrugged off these types of ratings actions, focusing more on the broader macroeconomic picture. Germany is now the largest economy with a Aaa bond rating, followed by Canada, Australia, and The Netherlands, according to the CIA World Factbook. These markets are generally much smaller than the US; thus, the US is likely to retain a large share of global fixed income and currency-related flows even after this latest downgrade.

Rising long-term yields is a negative for rate-sensitive sectors such as housing and broader equity market valuations, historically speaking.

The US dollar is down approximately 6.8% year-to-date (YTD) through Friday May 16, 2025 – highlighting the need for diversification across global assets and sectors. The dollar index was lower in early Monday trading.

Inflation has cooled (for now). The labor market has slowed, but layoffs remain limited. The overall economy is holding up, but consumers and businesses remain concerned about tariffs and prices. And just because tariff/trade policy has yet to affect the economy thus far, doesn’t mean that it won’t affect the economy later this year.

Last month, inflation as measured by the Consumer Price Index (CPI) grew at the slowest pace since early 2021. The question is – will it last?

As inflation has slowed, the economy has cooled. The unemployment rate bottomed about three years ago and has stayed in a relatively tight range ever since. In recent months, it has taken unemployed workers slightly longer to find a new job, according to data from the Federal Reserve Bank of St. Louis, but overall layoffs remain stable.

There are a wide range of estimates for Q2:2025 real GDP growth, but the consensus is that growth should be positive in the quarter. The economy still seems okay despite the recent wild gyrations in the stock market.

Corporations are more frequently citing the following words on conference calls, according to FactSet: “tariff(s),” “uncertainty,” and “recession”. Consumers are increasingly worried about increasing prices, according to University of Michigan survey data.

Bottom Line:

Investors should use the recent stock market rally to reassess portfolio positions. If necessary, investors should rebalance by removing overweight positions to US equities. Both international equities and real assets can provide important diversification to portfolios.

Staying invested throughout market volatility can be challenging. A liquidity bucket with sufficient cash reserves is a very important part of goals-based financial planning.

Cash reserves can ensure that an investor has the flexibility to stay invested with the majority of his/her assets and will not be forced to sell at an inopportune time. Staying invested is not an all-or-nothing proposition.

Investors should stay “Neutral to Risk”. “New Tools”, such as alternatives and real assets, should be used where appropriate to increase diversification. Investors should plan for a wide range of outcomes.

Equity Takeaways:

Stocks fell in early Monday trading. The S&P 500 dipped approximately 0.6%, to 5924, while small caps fell approximately 1.3%. International shares were outperforming as the US dollar index slipped approximately 0.8%.

The S&P 500 has bounced sharply off the April lows on improved sentiment surrounding tariffs. A price point of 5725 was thought to be a possible resistance level, but the market charged higher.

Earnings season for Q1:2025 was strong. S&P 500 earnings rose approximately 13.6% year-over-year versus expectations for 7.1% year-over-year growth, according to FactSet. Earnings growth has provided important support to the stock market in recent weeks. The recent rally was not just about improving sentiment regarding tariffs. That said, earnings expectations for Q2:2025 have been reduced, and there are roughly six weeks remaining until the current quarter ends.

During the recent bounce, cyclical stocks have outperformed relative to defensives, a positive sign for the broader market and economy. Cyclicals typically outperform when expectations for growth are increasing. Through May 16, 2025, the two strongest sectors YTD have been industrials and financials.

Financials are cyclical and benefit from strong economic growth. The sector could also benefit from deregulation. Financials have shown solid relative strength in recent weeks and look poised to test the sector highs set earlier this year.

Healthcare stocks are classic a defensive sector and have lagged since the April bottom. The healthcare industry is also facing the specter of increased regulation.

Real Estate Investment Trusts (REITs) may complement a core private real estate portfolio. REITs offer greater exposure to specialty sectors (cell towers, data centers, etc.) relative to the private market. REITs act more like equity over the short-run and more like real estate over the long run. In addition, they may also provide useful diversification to a total portfolio.

Fixed-Income Takeaways:

Treasury yields were generally higher last week as investors moved towards riskier assets. The Moody’s downgrade late last Friday caused yields to rise another 5 basis points on the long end of the curve.

In early Monday trading, 2-year Treasuries were yielding 4.00%, 5-year Treasuries 4.12%, 10-year Treasuries 4.52%, and 30-year Treasuries 5.00%.

The US is the sole sovereign issuer of the US dollar, the world’s reserve currency. Demand for US Treasuries will likely remain high even after the Moody’s downgrade, in our opinion.

In the past, market reaction to the downgrade of US debt has generally been temporary. The initial downgrade of US debt occurred in 2011, by S&P; Fitch downgraded the US in 2023.

The current situation sees investors worried about long-term US fiscal deficits, with inflation still above the Federal Reserve’s (Fed’s) long-term target of 2%. The situation in 2011 was different; back then, investors were primarily concerned with slow economic growth.

Market participants continue to expect several Fed rate cuts later this year. Expectations are for approximately 0.50% of fed funds rate cuts by year-end. The current fed funds rate is the target range of 4.25% to 4.50%.

Credit spreads have retraced much of the widening we saw in April. In general, credit spreads are not showing signs of stress. We continue to favor high-quality issuers in client portfolios.

Key Takeaways:

Early Monday morning, the US and China agreed to substantial tariff cuts for 90 days. Stocks rallied sharply on this news.

The US will lower tariffs from 145% to 30% on Chinese goods; “reciprocal” tariffs will be lowered from 125% to 10%; and 20% tariffs tied to fentanyl will remain, according to the Wall Street Journal (WSJ).

China will lower retaliatory tariffs on US goods from 125% to 10% and will also suspend or cancel retaliatory non-tariff measures such as export restrictions, also according to the WSJ.

Overall tariffs on Chinese goods will be approximately 40%, up from approximately 10% when Trump took office. It is unclear what will happen after the 90-day rollback period ends.

First quarter 2025 earnings season has been better than expected.

S&P 500 earnings growth for Q1:2025 is tracking towards 13.4% year-over-year, versus expectations for 7.1% growth, according to FactSet. Earnings season is nearly 90% complete.

S&P 500 revenue growth for Q1:2025 is currently 4.6% year-over-year, slightly better than the 4.3% growth analysts expected coming into the quarter.

Reported earnings growth has been positive across ten of the eleven S&P 500 sectors. The energy sector is the only sector that has shown a drop in earnings during the first quarter, a small dip of only 0.4%.

“Hard” economic data is holding up, while “soft” data is weakening.

The labor market is softening, but not collapsing. Initial unemployment claims have remained stable in recent weeks, while employee layoff announcements have ticked slightly higher, according to Evercore ISI. Private sector job growth and real wage growth have also remained relatively stable.

Contrast this “hard” data with “soft” indicators, such as surveys. Items such as consumer sentiment, homebuilders’ sentiment, and policy uncertainty indices are all showing high levels of concern.

Oil vs. gold – a tale of two real assets.

Oil prices have been falling for most of 2025 after a rally towards the end of the Biden administration. Several weeks ago, OPEC+ increased output, led by Saudi Arabia, which has put continued pressure on prices. In early Monday trading, oil prices were rebounding sharply amidst positive sentiment around trade.

Gold has been seen as a safe-haven asset during the recent trade/tariff turmoil. As markets have begun to normalize, gold prices have fallen from their peak.

We continue to recommend that clients pursue fully diversified portfolios, including allocations to alternatives and real assets where appropriate.

Bottom Line:

Investors should use the recent stock market rally to reassess portfolio positions. If necessary, investors should rebalance by removing overweight positions to US equities. Both international equities and real assets can provide important diversification to portfolios.

Staying invested throughout market volatility can be challenging. A liquidity bucket with sufficient cash reserves is a very important part of goals-based financial planning.

Cash reserves can ensure that an investor has the flexibility to stay invested with the majority of his/her assets and will not be forced to sell at an inopportune time. Staying invested is not an all-or-nothing proposition.

Investors should stay “Neutral to Risk”. “New Tools”, such as alternatives and real assets, should be used where appropriate to increase diversification. Investors should plan for a wide range of outcomes.

Equity Takeaways:

Stocks were sharply higher in early Monday trading. The S&P 500 rose approximately 2.5%, to 5803, while the tech-heavy Nasdaq rose approximately 3.5%. Small caps rose by more than 4.0%. International shares lagged their US counterparts, contrary to recent trends.

After a peak-to-trough decline of 20% like we saw in April, once the stock market retraces 50% of its original selloff (as it recently did), it rarely retests the recent lows. New highs in the S&P 500 are likely in the coming weeks and months.

Implied volatility (VIX) has returned to normal levels. In early Monday trading, the VIX was 19.5, near its long-term average. The 3-month VIX futures curve has un-inverted, another positive signal.

Several important S&P 500 momentum signals may trigger today, including new 20-day highs over 50% of total issues, and 90% of total issues above their respective 20-day moving averages. Both were very close to triggering last week.

Fixed-Income Takeaways:

Treasury yields rose across the curve in early Monday trading as “risk on” sentiment prevailed. Short- to intermediate-term yields rose faster than long-term yields, bucking the recent trend.

In early Monday trading, 2-year Treasuries were yielding 4.00%, 5-year Treasuries 4.10%, and 10-year Treasuries 4.45%.

Last week, Federal Reserve (Fed) Chairman Jerome Powell indicated that the Fed is in no hurry to cut interest rates. Powell’s comments, combined with improving sentiment on the economy, have caused market participants to push out expectations for rate cuts.

Early on Monday, interest rate futures were pricing approximately 50 basis points of rate cuts in the fed funds rate by the end of 2025, down from recent expectations of 75-100 basis points of cuts this year. The current fed funds rate is the target range of 4.25% to 4.50%.

Recent data shows that foreign investor demand for Treasuries remained strong in April. Several weeks ago, there had been some concern that foreign investors were reducing their US Treasury holdings, but that theory has been debunked for now.

Credit spreads have reversed much of their recent widening, as “risk on” sentiment has returned. Both investment-grade (IG) and high-yield spreads were sharply tighter in early Monday trading.

The Fed’s Tightrope:  Balancing Inflation and Growth Amid Tariff Turbulence.

Key Takeaways:

• The Federal Open Market Committee (“FOMC” or “The Fed”) left the target range for the federal funds rate unchanged at 4.25% to 4.50% 
• The rate decision was unanimous
• The rate on bank reserve balances was unchanged at 4.40%
• Balance of risks shows a greater concern about rising inflation and rising unemployment

The Fed Holds Rates Steady Amid Rising Economic Risks

The Federal Reserve left interest rates unchanged at 4.25% to 4.50%. The rate paid on bank reserve balances also remained unchanged at 4.40%, and the pace of balance sheet reduction was also left unchanged. This marks the third consecutive meeting where interest rates were held steady, reflecting the Fed’s commitment to its dual mandate of promoting maximum employment and stable prices.

Statement Tweaks that Speak Volumes

The most telling change came in a subtle shift of language in the Fed’s statement:  The Committee now says there has been a “lack of further progress” toward the 2% inflation target – a notable downgrade from March’s “some further progress.”  This acknowledges recent sticky inflation prints and a growing concern that disinflation may have stalled.

The statement also noted that “uncertainty about the economic outlook has increased further,” reflecting the Committee’s concerns about fiscal, trade, and immigration policies under the current administration.  These evolving dynamics add new risks to the Fed’s ability to manage both inflation and employment.

Powell’s Message:  No Rate Hikes, But Still on Hold

In his press conference, Fed Chair Jay Powell took the possibility of additional rate hikes off the table, stating, “it’s unlikely that the next policy move will be a hike.”  At the same time, he reiterated that cuts will only come when the Fed gains “greater confidence” that inflation is sustainably returning to target. Moreover, Powell emphasized that the Fed would only act after economic data deteriorated, stating: “It’s not a situation where we can be pre-emptive because we actually don’t know what the right response to the data will be until we see more data”.

The Fed’s current posture is neither hawkish nor dovish – it is one of “strategic inertia,” seeking to avoid overreacting to near-term volatility in inflation while remaining open to future easing if conditions allow.

Market Reaction:  Subdued, Yet Supportive

Markets responded with cautious optimism.  The S&P 500 rose 0.8%, led by tech and other rate-sensitive sectors.  Treasury yields declined, with the 2-year Treasury falling approximately 7 basis points; and fed fund futures moved to price in three rate cuts totaling 75 basis points by year end.  The dollar weakened modestly, while gold ticked higher.

Conclusion:  A Strategic Stall

This FOMC meeting was about holding the line without tightening the screws.  The Fed’s message was clear:  we’re not moving yet, but we’re watching closely.  For now, Powell’s tightrope act looks stable – but investors should expect more sways before the final descent begins.

Key Takeaways:

The initial shock from tariffs may have passed, and the stock market has rallied in recent weeks. However, tariff-related aftershocks may still lie beneath the surface.

The S&P 500 has rallied nine days in a row and has returned to pre-Liberation Day (April 2, 2025) levels. Through Friday, May 2, the S&P 500 was down just 2.9% year-to-date (YTD).

In recent weeks, investors have focused on potential positives instead of potential negatives. A pause in tariffs, progress in Ukraine, and monetary/fiscal stimulus outside the US have all supported global stock markets in recent weeks.

Beneath the surface, in Q1:2025, US net exports saw their largest collapse since World War II, according to Bianco Research. Trade between the US and China appears to be significantly slowing, according to Apollo, although the data is noisy.

US economic growth forecasts have been significantly lowered, while forecasts for inflation have significantly risen.

Entering 2025, analysts were optimistic about US GDP growth, but those forecasts have been revised lower over the past few months. At the same time, forecasts for US inflation have risen.

Conversely, in the European Union (EU), estimates for economic growth have remained stable, as have forecasts for EU inflation. On a relative basis, EU forecasts have improved versus the US, which is one reason European equities have outperformed US equities in 2025.

The hard data in the US remains solid. Consumer sentiment is very weak.

Real Final Sales to Private Domestic Purchasers is a measure of US GDP that excludes government expenditures and gross inventory changes. This metric remained stable in Q1:2025, growing at a solid 3.0%, according to Bianco Research. Underlying demand in the economy appears intact.

Another sign of strength: US nonfarm payrolls grew by 177,000 in April, above even the most optimistic estimate. The unemployment rate was unchanged at 4.2%. Tariffs did not seem to significantly affect employment in April.

Consumer sentiment has dropped sharply at all income levels, according to Apollo. That said, even though consumers are gloomy, they continue to spend, with Redbook same store retail sales still growing at a solid clip, according to Apollo.

Bottom Line:

Investors should use the recent stock market rally to reassess portfolio positions. If necessary, investors should rebalance by removing overweight positions to US equities. Both international equities and real assets can provide important diversification to portfolios.

Staying invested throughout market volatility can be challenging. A liquidity bucket with sufficient cash reserves is a very important part of goals-based financial planning.

Cash reserves can ensure that an investor has the flexibility to stay invested with the majority of his/her assets and will not be forced to sell at an inopportune time. Staying invested is not an all-or-nothing proposition.

Investors should stay “Neutral to Risk”. “New Tools”, such as alternatives and real assets, should be used where appropriate to increase diversification. Investors should plan for a wide range of outcomes.

Equity Takeaways:

Stocks fell in early Monday trading. The S&P 500 fell approximately 0.6%, to 5651. Small caps dipped approximately 0.7%. International shares bucked the trend and were generally higher.

Through last Friday, May 2, the S&P 500 had closed higher 9 days in a row. The S&P 500 is down only 2.9% year-to-date after its recent rally.

The S&P 500 index made a new 20-day high last week, which marked a significant shift in tone. Investors have changed their focus to what might go right, instead of what might go wrong. The S&P 500 has never fallen 20% and then retraced 61.8% of the fall (as it recently did), and failed to make a new all-time high.

Traditional measures of market breadth have improved; however, some indicators are still mixed. New 20-day highs of individual S&P 500 components are just 33%. This metric typically moves above 50% during long-term bottoms.

Options investors are not bearish. The equity put/call ratio shows increased call buying during the recent rally. This indicator implies that investors are becoming overly confident.

Speculative positioning in Nasdaq-100 futures is also optimistic. Large speculators (aka hedge funds) aggressively bought the dip in the Nasdaq in recent weeks.

Contrast these ratios with traditional sentiment indicators, such as the American Association of Individual Investors (AAII) survey. Various surveys continue to indicate that investors remain bearish. Investors seem to be positioned more bullishly than survey responses would indicate.

Private capital secondary funds are a special class of alternative investment. Secondary funds buy assets at a discount out of existing private equity or debt portfolios and place these assets into a new vehicle.

With private capital fundraising down, and potential forced selling by large institutions, secondary funds are in good position to take advantage of dislocations in the market.

Fixed-Income Takeaways:

Last Friday’s favorable jobs report pushed Treasury yields higher across the curve. Credit spreads tightened sharply on Friday in response to the jobs report as sentiment around risk assets continued to improve.

In early Monday trading, 2-year Treasuries were yielding 3.84%, 5-year Treasuries 3.94%, and 10-year Treasuries 4.34%.

With hard economic data remaining strong and inflation expectations rising, the chances for a fed funds rate cut in May have dropped to essentially 0%. Market participants are pricing approximately a 40% chance of a 25-basis-point rate cut in June. The current fed funds rate is the target range of 4.25% to 4.50%.

Municipal bond yields were lower last week as investors moved into the sector. The ratio of municipal yields to Treasury yields has fallen in recent weeks – investors have “bought the dip” in municipals.

Across the curve, municipal bond yield ratios are about 75% of Treasuries. Municipal bonds are still attractive relative to Treasuries, although not as attractive as they were several weeks ago.