Key Private Bank Investment Brief

General Takeaways:

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

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

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

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

   
   

2. The outlook for inflation is also perplexing.
   

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

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

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

   
   

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

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

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

   
   

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

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

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

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

   
   

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

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

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

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

   
   

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

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

   
   

Equity Takeaways:

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

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

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

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

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

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

Fixed Income Takeaways:

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

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

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

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

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

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

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

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