Key Wealth National Call: Managing Wealth During the Fog of War, AI Disruption, & an Uncertain Economic Path
Brian Pietrangelo [00:00:00]
Good afternoon, everyone. It is 4 p.m. on the East Coast, and we'd like to welcome you to the Key Wealth National Call, Managing Wealth During a Fog of War, Artificial Intelligence Disruption, and an Uncertain Economic Path. Again, we'd like to welcome you to our conference call today, and share with you some of the updates in what's happening in the world today, and why it's so important to provide you with that update. I am pleased to be joined by a number of my colleagues within the Chief Investment Office. I am Brian Pietrangelo, Managing Director of Investment Strategy, and I am joined by our Chief Investment Officer, George Mateo. I am also joined by our Head of Fixed Income, Rajiv Sharma, and our Head of Equities, Steve Haight. So we have a tremendous Agenda for you today to bring forward a lot of information that we know is on the top of minds on a lot of our clients and our investors. In terms of the instruction for the call, you do have a little button on the bottom of your screen that is labeled Q&A, as is shown on the screen right now. If you click that button, you'll open the Q&A window, which allows you to ask questions to the panelists on the call today. And if you do type a question into that window and then hit send, it will be addressed by one of us. We will address it one of two ways. Either we'll address it verbally on the call live, if we have a chance, and it's consistent with the slide that we're on, or the topic that we are discussing, or we'll be able to send an email or a different chat back to you in terms of trying to respond. If we don't get to it by the time that the call ends, we'll try to follow up with you individually if we can. So with that. It's a great opportunity to start the conversation with our Chief Investment Officer, George Matteo, to give us the key takeaways that we think are most important for you to consider, and then we'll go into the details of each as we progress through the hour. Thanks, George.
George Mateyo [00:01:56]
Brian, thank you very much, and thanks to all who joined. Appreciate you making the time to be with us today. Before I jump into the conversation, though, I want to say two quick things. First of all, we are obviously going to be talking about war, and strife, and conflict, and that's really never fun, frankly. We have to acknowledge, though, that there's a real price to that, and I don't want to be cavalier about that. So, despite the fact that we'll be talking about markets and economies, there's a real price to pay here, and that's, of course, the human sacrifice that comes with war. And again, I don't want to minimize that in any way or feel callous and overlook that. The second thing, as we prepare for the holiday season that's upon us, I want to take a quick minute also and just wish everyone who celebrates a very joyous and a meaningful Easter and Passover. We appreciate being with us during this time, and we hope the holidays in front of us are joyful and meaningful, as I said. So that being said, I did want to take a few minutes, as Brian mentioned, to walk you through some key takeaways and put some context around what has happened in the past few weeks or so. I think it is fair to say that the phrase that Vladimir Lenin first uttered some hundred years ago or so, when he said that weeks happen… there are weeks when decades happen. Which, frankly, would be a very apt description for what's taking place thus far in 2026. That being said, aside from some significant volatility, I think by all accounts, markets have performed largely as expected. There's a few surprises, but it's not atypical to see markets under some pressure when we have these events, such as we've seen in the past few weeks or so. And there are a few surprises, too, which we'll talk about, but I think overall, markets have been fairly well behaving as expected. I have to say that they've been immune from sell-offs and some pressures, but generally the expectations around geopolitical events are associated with market declines, and that's what we've seen thus far in the past few weeks. Going forward, the idea of where we might head from here is really predicated on what happens, of course, with the price of energy, and oil more specifically. Assuming that oil prices hold where they are roughly now, at roughly $100 a barrel, we think it's fair to say that we'll probably see an uptick in inflation. We'll also probably see some slower growth, but at the same time, we don't see… we don't envision a scenario right now where a recession will happen and occur in the U.S, again, assuming that prices stay at current levels. We would also anticipate that corporate profits can hold in. We see pretty good corporate profit growth across much of the economy, but it won't be uniform going forward, given the fact that these prices at the pump and other raw material prices are something that's unavoidable in many companies, so I think selectivity will be more important going forward as well, but all as equal, we're not expecting a recession at the moment, and we still think that corporate profitability can be maintained. That being said, we do think it's a very real phenomenon that a hormones premium will probably be baked into prices going forward, in the sense that oil prices and gas prices and other commodity prices will probably be staying higher for longer. I would also acknowledge that downside risks still remain, in the sense that there's, frankly, a lot of fragility in the Middle East that needs to be acknowledged, and we can see that very evident, being evident all the time. We also acknowledge that there is, frankly, a lot of uncertainties elsewhere. We'll talk about some of those this afternoon. We'll talk about, for example, the disruption that's happening from and within artificial intelligence. We'll talk briefly about some of the pressures confronting private credit. And also, we have to acknowledge that the U.S. labor market is still slowing. At the same time, changes at the Federal Reserve are coming later this year as well. So, given that backdrop, we think it's important to acknowledge that investors will need new approaches when respect to portfolio construction as we confront new challenges. One thing that's steadfastly clear of, however, is that we do not advise… again, we don't advise market timing. In other words, trying to time when markets might be going up or down on charts or bases. But instead, adhering to your long-term financial plan is really paramount during these times of uncertainty. So with that, I'll walk through a few highlights in terms of how we arrived at where we are, and bring Steve and Rishi in conversation as well to get their insights along the way. Turning to slide 6 is a quick, really, recap and summary of some major indicators and their performance year-to-date and also month-to-date, knowing that the fact in the last 30 days or so really marks the demarcation line between the time with which the Iranian War situation began. As I mentioned earlier, there's not too many surprises here, and I think it was maybe a bit more of a shock than people realized at first. But it really didn't surprise us too much to see the price of oil and price of gasoline surge as much as they did when the conflict first broke out. In fact, Steve, I remember pretty distinctly you talking about $100 a barrel on crude would be something that could probably be in the cards, and indeed, that's what we got. We'd also acknowledged that interest rates moved a little bit higher, maybe more so than we would have anticipated, but nonetheless, when you have an inflationary shock, it's not surprising to see some backup in yields, as the overall market anticipates, perhaps, more inflation that the Federal Reserve and other central banks have to contend with to try and get that inflation back under control. Admittedly, we're making good progress, though, so coming into the conflict at the end of February, you can see rates, both Treasury yields and also mortgage yields, had come down. We were getting very close to that 6% threshold on the housing, the key housing indicator of the mortgage rate of a 30-year mortgage. And we didn't quite get there, and now rates have backed up. As you can see, they're across the board, both on 10-year Treasury yields and also mortgage rates as well. Equities didn't, we're not immune from this, and again, it's not atypical to see equities sell off when you have geopolitical events such as this. And indeed, that's what we got. We actually had a bit of a recovery yesterday, which is certainly welcome news, and a bit of a reprieve. And then gold is something that maybe surprised us a little bit, in the sense that typically we start to see gold rally in times of geopolitical events, but admittedly, gold had a very, very impressive run coming into this, and so to some extent, it was not surprising either to see profit-taking ensue there as well. Turning more to some of the more detailed information, again, I won't go through this in detail, but here graphically in slide 7 is some information about performance, as we've seen things play out in the past few weeks or so. The chart on the left captures the index returns since the war began, and again, it's more of a mirror image of what I just talked about, in the sense that we see oil prices surge, we start to see risk assets, such as stocks, which are labeled in blue, start to sell off. And also, again, as I pointed out, gold actually slumped quite notably, falling some 13% since the war began. Year-to-date, the story's a bit more nuanced, which is the chart on the right, and it shows you some similar patterns. Again, not surprising to see the price of oil move higher in a meaningful way. But we've also seen some vibration with inside the overall markets, in the sense that certain categories of stocks have actually outperformed others. And certain categories and bonds have done the same, which we'll talk about in a couple minutes ahead. So, let me move on in terms of recapping some things that have happened thus far this year. Many of us woke to the first weekend of the year, to the news that Venezuela was being essentially, taken over, if you will. I guess maybe that's one way to put it. We saw a change in leadership there in a really abrupt fashion. There was also some conversation around further activity in Greenland, which soon became known as the Donroe Doctrine. And then over the course of the quarter, we saw many events take place inside the courthouses and other places as well, where you saw a significant reversal and significant changes with respect to tariffs, only to be changed again, in the sense that once the Supreme Court decided to, strike down the ruling around… strike down, essentially, the use of IEPA tariffs that the administration had previously put forth. The administration promptly responded by imposing new tariffs as well. So, tariffs are still an uncertain moment, and we won't talk about that very much today, but that's still an event that is still looming large and facing many businesses and individuals as well. And then more recently, we saw some significant turmoil and events regarding the central bank, notably the Federal Reserve. which essentially has been kind of an on-again, off-again political saga that we've had to acknowledge from time to time as well. But irrespective of that, I think it's still going to be a case where we will see some changes at the Federal Reserve later this year that Rieve will talk about in a few minutes. So, on to Operation Epic Fury. Of course, this is the more recent event that really catalyzed a lot of market activity. It certainly brought forth a lot of conversation. And again, if you just look at the chart on the… really, the image on the… on page 10 here, it shows you, essentially, really what has been the key focal point in the past few weeks, which is the Strait of Hamuse. You can see where it's geographically located, and essentially, it's really kind of the epicenter of why we're having this conversation today around market performance. Having a conversation around economic output and impacts. And other geopolitical events as well, really hinge on that key part of territory, as depicted on the slide here, slide 10. Now, why is the cerebrum use so important? And I think it's fair to say that it really represents a very critical choke point for energy overall. If you look at slide 11, what we try to do is quantify, essentially, how much oil flows through the Strait of Hormuz on a daily basis when it's open. And I'll talk about more of that in a second. But, Steve, I know you've been a student of this, and you've paid attention to this. How significant, in your view, is this Strait of Hamuse from an investment perspective?
Stephen Hoedt [00:11:32]
It's… it's the most important choke point globally, period, the end. Simply put, the… Energy markets, energy in general, is the lifeblood of the global economy, and not only do you have 20% of the world's crude oil moving through there, but also a very large percentage of the world's global… liquefied natural gas, both of those going through that same choke point on a daily basis. And simply put, when you remove those barrels from the global market, price has to move higher in order to cause rationing. And in particular, rationing in the Asian marketplace for crude oil. About 10 million barrels have found other ways to get to the market so far, so that 20 billion… a million barrels a day is a little bit of a… You know, it's a… it's a number that's moving around, but clearly things are not happening the same way that they did a month… a month and a half ago.
George Mateyo [00:12:36]
Indeed. So, to put a finer point on that, slide 12 is somewhat of a busy slide, but if you just pay your attention to the chart on the right. it shows you, I think, a very key point, in the sense of… it's important to acknowledge, really, where this oil is going on a global basis. And I would draw your attention to that, that pale blue, color, essentially, that represents the amount of oil, the percent of oil, rather, and it's really based on dollars as well. But essentially, the amount of oil that's flowing to China, places like India, and other parts of Asia. So Asia, essentially, has been a really, important part of the conversation in terms of the fact that much of the oil that actually is shipped out of that Strait of Hammuz goes into energy markets around Asia. The U.S, which is that grayish bar on the right-hand side of slide 12, is much less of a factor, and that's one reason why U.S. markets have actually held up comparatively better than other parts of the world, in the sense that we as a country right now are less dependent upon oil from other parts of the world, namely the Middle East. Now, the street itself, again, I'll just talk about this briefly. This is, again, just what Steve reiterated in the sense that we've seen numbers move around quite a bit, but all… by all intents, essentially, traffic in and out of the Strait of Ramuse has essentially stopped and ground a halt. Now, I think it is fair to say that we are getting some signs in the last literally 24 hours or so that we may be nearing the beginning of the end of this conflict. And indeed, later on this evening, I believe the President is addressing the country And we'll be talking about, potentially, his plans to wind down, this conflict. It's fair to say that there's a lot that could be kind of put forth in terms of how this actually gets implemented. It might not be the quickest end-to-war either, but I think nonetheless, we do see some optimism, and the markets have certainly reflected that in the last few days or so. We also have to acknowledge that when we talk about ending the war, this might prove challenging in the sense that some of the other parties involved, namely the Israelis and other parts of the Middle East, may want to keep fighting. And frankly, we just don't know exactly how many different scenarios might play out, but frankly, there's a lot of uncertainty with respect to actually winding down this conflict. And indeed, I think what we've seen in the last few hours from their ratings suggests that they, too, might have something to say about this going forward as well. Most unknown, I guess, is really the extent of aftershocks in terms of what happens when the strait is officially open. To some extent, many people think that this conflict could actually have a ripple that could last years in some cases because of the major amount of infrastructure that was damaged as a result of the conflict. So, I think there's fair to say that there's still a lot of fragility that still exists, a lot of unknowns, and I think because of that, the markets probably will be somewhat volatile in the weeks and months ahead. Now, I think it is fair to say also that if we think about maybe more specifically around the price of oil, to me, this is probably the key thing to watch in terms of the overall impact on the economy. Steve, would you agree with that?
Stephen Hoedt [00:15:31]
Absolutely would, George.
George Mateyo [00:15:34]
Yeah, so I think it's fair to say that we've seen some significant, price action, and you can see clearly this is just mirroring the data I showed you at the beginning of the slide, of the conversation, where the price of oil moved closely to $100 a barrel, and it has remained there roughly ever since. I think on a positive note, it is important to note that the world itself has become far less dependent on oil in general. So if you look at the overall consumption of oil relative to the size of the economy. Back in the 70s, it was quite a very intensive economy. We're now more of a service economy in the sense that much of the output that we produce is service-based, it is not manufacturing-based. Manufacturing is still very important, however, but overall, we consume less energy than we did in the past, and we can probably see that in the way we live our lives on a daily basis. So in a very positive way, this conflict came at a, I guess, a relatively okay time. There's never really probably a good time for this, but it came at a time where the world is less dependent on oil in general. We also have to acknowledge the U.S. itself is a net exporter of oil, meaning, essentially, most of the oil that we consume as a country, we make ourselves. And so for that reason, some of the impact that we've seen thus far has been less acute here in the U.S. relative to the other parts of the world. If you draw your attention to slide 18, and you look at the very bottom part of the page, for example, you can see the overall amount of exports coming out of the U.S. and going to the rest of the world has been on the rise. That's the gold line on the bottom part of the page on slide 18. At the same time, our consumption, which is the blue line, has come down, and our production, which is the brown line, has moved up quite meaningfully. So again, I think the key takeaway here is the fact that we as a country are not only producing less oil, we're using less of it, and that's actually been one of the reasons why we've been somewhat immune to this recent conflict from the economic perspective. Conversely, we have to acknowledge that the U.S. and the rest below, too, is far more indebted, meaning we essentially have more debt on our balance sheet than we did at any one point in history, and should the extent that we face some slowdown, this would become more acute and somewhat, perhaps, painful as well. Right now, it is not a problem that we have to contend with, but it's something that is still… needs to be addressed in the long term for us to sustain our growth as a country going forward, in our view. Now, I think if we think about what happens going forward, if we think about maybe where crude prices could trend. These are looking at future contracts. The blue line is the current contract ending in February. The brownish-red line is the contract that will end in March, that has ended in March. And by all accounts, these moves… these curves, especially, could move around quite a bit. But based on credit expectations, we see a slowly, gradually decline in energy, but somewhat elevated. So, in other words, it probably won't be until the end of this year where crude is back to sell, call it $80 or so, a barrel, down from $100. And that's… that's something to change. Frankly, these curves are essentially just a guess on where maybe prices could go. But nonetheless, the trend here is downward, but it'll take some time to get probably back to where it was before the war started. Why is that the case? I think slide 21 drives that home… that drives that point home very clearly, in the sense we now are seeing the biggest shock to supply in history. So, irrespective of what happened in the great 70s, of course, that was a pretty big shock as well, but that happened over many years. We've seen some other shocks along the way, such as the Gulf War, the 9-11 fallout, the Great Recession in 2008-9, and even the more recent events in Ukraine and Russia. But relative to other periods of time where we've seen significant supply shocks, this is, by all accounts, the biggest supply shock in our history. So for that reason alone, I think it's fair to say that the price of oil will remain somewhat elevated and come down gradually, as posing to come down more suddenly and sharply. So if I tie this all together, Moody's Analytics had some really great ways to try to summarize this and kind of put a finer point on the overall economic impact. Their assumptions were somewhat similar to ours, in the sense that they would think that the price of oil would come down, but not quickly, and come down over time. And in those scenarios, you can see, essentially, that there is going to be a real impact in terms of what we pay at the pump, what consumers spend on a daily and annual basis. how that actually would affect their budgets, more specifically, and what does that mean for the overall level of inflation and the overall level of GDP, or Economic output, essentially. By all counts, based on their statistics and their analysis, they would expect to see a rise in inflation of about 15 basis points. 0.15%. And a slight decrease in growth of about 10 basis points, or about 0.1% as well. Now, if energy prices stay elevated, and if you can kind of see a sustained level of prices of $110, $120 or so a barrel. That would mean even more hardship for many consumers, that would be a bigger dent toward inflation, in terms of inflation moving higher, and also that would suppress growth by roughly one-half of 1%, or 40 basis points. So, net-net, the impact by these estimates, anyway, suggests that inflation will be somewhat higher. Growth will be so much slower. And I think, also, wealth inequality will also be wider going forward, all as equal.
Brian Pietrangelo [00:20:50]
So, George, great summary. Before we go to the next section, there's two questions in the Q&A that I think would be good timely, given that we just spent a decent amount of time on oil and Iran. So, Steve, these are both going to come to you. The first one is, any curiosity why Europe is reluctant to engage? And the second question is, what about U.S. oil, and is it a type of oil that requires we still import some oil from outside the United States?
Stephen Hoedt [00:21:16]
So, the second question, is the easier one of the two to answer, and that is yes. So, there… refineries are set up to process a certain specific type of crude, and our Gulf Coast refineries, where the bulk of the refining is done in the United States. are set up to refine heavy crude. The two largest sources of heavy or sour crude are from the Canadian oil sands, and we have pipelines that bring that stuff down to the Gulf for processing. The other source of it is sour crude, heavy crude from Saudi Arabia. So, we tend to import that, and then export the higher dollar value light sweet crude that comes out of the ground in West Texas. And this is just an artifact of the way the refineries were set up prior to the shale boom. And you have to understand that it costs billions of dollars to retrofit a refinery to be able to process different types of crude oil, so it's never made economic sense for the United States to change those refineries over to process, West Texas Intermediate. So we just rely on the global markets to balance everything out. So that's the first one. Second one's complicated, because the Europeans don't have energy independence, so they're kind of beholden to go along with what happens in other places. And they also are very close to the Middle East in terms of location, so they're very sensitive to doing things that could cause a refugee influx into the region, so they… they would prefer to see things be resolved in a very peaceful fashion to keep refugee situation much more under control. And granted, again, there's a lot of people stuff here when we talk about this, and I don't want to sound callous, but Like, they make decisions based on what's best for their situation, and their best situation in this is to not engage, because they don't want to see an influx of refugees into their region.
Brian Pietrangelo [00:23:18]
Steve, thanks for addressing both of those questions in a timely basis. And now, Rajiv, we'll bring you into the conversation. How does all this economic and geopolitical activity affect yields and rates?
Rajeev Sharma [00:23:29]
Well, Brian, I mean, rates have moved sharply across the Treasury yield curve, and if we focus on the 10-year Treasury note yield that's shown here, that yield has climbed into the 4.3% to 4.45% range over the past 1 month, and these are big moves. These are the highest levels we've seen since mid-2025. We hit a peak of 4.44% on March 27th. So this is a clear, sustained repricing higher in the long-term rates, and it's directly tied to a combination of macro and geopolitical factors. We have sticky inflation and the fear of rising inflation, which is causing the market to increasingly price the risk that the Fed would at least keep rates higher for longer. And the probabilities of a rate hike have also been gathering some steam over the past few weeks. That's pushing term premiums higher. Then you have the Iran conflict. That's kept oil elevated, as we just mentioned, and volatility higher as well. So, investors are demanding more compensation for long-duration risk. If oil goes up, yields go up. And then we have a heavier Treasury auction supply that's coming to the market. You have larger fiscal deficits, rising debt levels. This has all added, long-duration supply into the market, and it's keeping pressure on yields to remain high. And the markets are really repricing long-run inflation and fiscal risk more than immediate Fed policy. These higher, longer-term yields, they tighten financial conditions without the Fed even doing anything. So mortgage rates, as we mentioned, and corporate borrowing costs, they all move in tandem with the 10-year Treasury note. What we need to keep an eye on here is the inflation data. Any surprise to the upside there will cause the tenure to move higher. We also need to monitor these Treasury auctions, how the investor demand is there. and all the geopolitical risks that are in the market right now, and any change in the Fed narrative. So there's a lot of factors that are causing these rates to move higher. Now, if we go to the next slide, you know, one thing that's very important here, we talk about rate cuts, and how does the market really perceive the future for rate cuts? At the start of the year, the market was confidently expecting multiple rate cuts for 2026. Today, those expectations have been pretty much priced out of the market. And just a few weeks ago, there was actually a 50% probability that we could have a rate hike this year. So Fed funds futures are pretty much all over the place, and they're gravitating towards zero rate cuts for the year, as you can see on this graph. The entire easing cycle has been pushed indefinitely into the future, and that's one of the fastest reversals that we've seen in rate expectations since 2022. So what made this happen? The market received a string of inflation data that was hotter than expected, that includes CPI, PCE, and wage data. That pushed the one-year inflation expectation sharply higher. Energy-driven inflation is now driving market expectations, and we see the bond markets reflect this because Fed action is not asymmetric. So if inflation rises, the Fed simply cannot cut rates. Fed Chair Powell came out and stated it very clearly. So even if the latest Fed summary of economic projections point to one rate cut for 2026, the market has clearly moved away from that. So essentially, at the end of 2025, the market was pricing in 6 to 7 rate cuts for 2026. Then that went to 3 cuts, and now we're somewhere between 0 and 1 cut for the year. Cuts disappeared not because growth is collapsing, it's more because of this inflation risk that's re-emerged. The Fed needs both disinflation and stable or falling inflation expectations, and if the Fed doesn't get that, which they're not getting right now, higher for longer is really the base case. And then if you want to extrapolate that into the odds of recession, they've increased as well. And here we see the betting odds through, Kalshi. These are simply what the public thinks at any given time. We did see odds of a recession increase over the last few weeks, and this is due to the disappearance of that rate cut expectation. Combined with rising long-term treasury yields, that means financial conditions are tightening. That alone, that itself, raises the recession risk. So, that is not in line with the Fed's call for a soft landing. Barring costs for households and businesses, they remain high, credit conditions remain tight. So you're going to have this fiscal drag with the U.S. more indebted, and then you have the rising interest costs and that crowding out that could happen with other spending programs. So the key here will be consumer resilience. Savings rates, delinquencies, and credit cards, these are going to be very important to monitor when you're thinking about recession risk. So if you want to add to that, the composition of the Fed is also changing. The Fed is entering one of the most consequential transition periods in decades. First, we have Fed Chair Powell. He's on his way, his term is ending in May of this year. You had Atlanta Fed, President Rafael Obastic, he also had retired, he announced his retirement, which again, opens up a key seat that could have influence on the rate-cutting, cycle. Trump picked Kevin Warsh to be the next Fed chair, and that's going to lead to changes on the interest rates. His agenda is pretty clear, he wants to have more rate cuts. And and he wants to cut the Fed's communication also with investors. He thinks that the Fed is too much in front of the investors. I don't know how that's gonna happen. I think investors really like the forward-looking statements that the Fed gives them at these FOMC meetings. It seems to me that Warsh wants to kind of get away from that, and have less dialogue, less narrative, and really focus not on future forward-looking statements, but more, like, how we can shape the future, with his policies. Now, his Senate confirmation remains on hold because of the objection from Senator Tom Tillis to the Justice Department for the probe of Fed Chair Powell. So that's also something the market's gotta grapple with sooner rather than later. And if we talk about oil prices, rising in turn of inflation forecasts rising, futures markets are increasingly raising the odds of the rate hike. And here, in this chart here, you can see the members of the Fed, and how they stand on the dove-hawk continuum. This is based on recent speeches recent narrative from these Fed members, and that's kind of how you put them on this chart, based on what they have been saying in public spaces. With the exception of Walker and Daley, they've leaned more dovish. You have Kevin Warsh and his stance on cutting rates, but Warsh would have to come up against institutional resistance from Fed staff and Fed governors. Warsh has clearly stated that he has a deep belief that the Fed has made a series of policy errors, and from… and those errors are from maintaining a long, large balance sheet right after the 2008 financial crisis, to missing inflation from the pandemic. So, he can't do this alone. You need a dozen… you have a dozen other voting members there, but the chair is often thought of… the chairman is often thought of as the first among equals, and he does wield a lot of power in swaying other votes. He sets the agenda for the committee, he directs organizational research, so he can ask for whatever research he wants, and kind of mold the opinion of the Fed. And recent events really do point to a lot of different things beyond what we're seeing here, beyond the Dovehawk continuum, there's been a lot of questions about the Fed independence, and that's been a big spotlight as well. We have an administration that's openly pressured the Fed to cut rates. You have the Department of Justice issuing subpoenas. There's a lot of stuff going on in the market right now that would lead to the spotlight of Fed independence. It creates legal and political challenges for the Fed, and the credibility where the Fed stands, credibility is number one. So I think the markets will have to watch whether the Fed can maintain that independence in the fate of such political intervention. And if we move on to credit markets, on this chart, we see the BBB minus B spread. Now, this is the cleanest measure of credit spreads, and where mild concern turns into real stress. It's the spread that bridges the investment-grade world and the high-yield world. We have seen the spreads widen modestly, but credit spreads have overall been quite well-behaved, and far from historical stress levels that you see here, as you can see the COVID-19 being a credit stress point that we saw back in 2020. Spreads are drifting wider as geopolitical events unfold. But still, they're pretty much in a calm to neutral territory. They're not flashing alarm bells. This is exactly what concerned, but not overly so, looks like. When spreads widen, it means that investors are demanding more compensation for downside risk, liquidity becomes thinner, and early credit cycle stress starts showing off. When spreads tighten, the market is signaling confidence again in corporate balance sheets. The market moves towards a risk-on mode. Right now, credit spreads are showing mild caution, no distress. There's been no liquidity issues, no forced selling pressures, and refinancing walls, in particular for investment-grade borrowers, they're just not there right now. So, right now, credit spreads are not really screaming alarm bells. I think everything is moving very smoothly for credit.
Brian Pietrangelo [00:32:31]
Thank you, Rajiv, and it's a good opportunity as we transition from public credit markets to private credit markets. George, there's been some news recently in private credit markets. Why don't you just say a few words for our audience on private credit and the… artificial intelligence.
George Mateyo [00:32:46]
Sure, Ryan, thank you, and Rajiv, excellent summary as always, so thank you for your insights. You know, Brian, I could probably do… we could do a whole call devoted to private credit, but we won't. But I think it is fair to acknowledge that it is something that's been certainly strolling around the news of late. I think it is fair to say that not all reports are really telling the full story. It's a very nuanced asset class in general. Effectively, private credit, though, refers to loans that are made privately, as the name suggests. But they're still loans nonetheless. There are companies that exist to pay coupons, and investors can essentially clip those coupons. But there's much more nuance than that, and what we've seen in the past two decades or so is there's tremendous growth in private credit in general, which, as we've said here, has fueled a virtuous cycle. Now, more recently, however, there have been some credit events, there have been some losses, some of which were due to fraud, which are really pretty much hard to underwrite or impossible to underwrite, but nonetheless, there has been some pressures regarding AI and its disruption in certain software companies, which we'll talk about in a minute. But I think it's fair to say that the story is very nuanced. I think people are right to be concerned about it. But if I think about private credit more specifically, I think it is fair to say that some of the concerns and the comparisons to 2008 are frankly inaccurate. I think to some extent, there are concerns that are legitimate. We have seen some deterioration in credit, but overall, credit, as Rajiv pointed out, has been pretty stable. If you look, for example, at the levered lending market as the size of the overall market today, it's roughly $2 trillion, and that's grown quite significantly in the last 10 or 15 years. But if that really, if you put that into comparison, into context against some of the public markets. And specifically the mortgage market, really, which was the epicenter of the crisis back in 2008, it really is much, much smaller. And at the same time, in terms of some systemic risks, I think the risks are very quite low. I think there probably are some interlinkages that need to be explored and probably will come to light over the next few quarters, but overall, banks today are much better capitalized than they were back in 2008 by a significant margin, so they should be able to withstand some of these pressures. Now, again, if you're interested in learning more about private credit, we published a deck A slide deck that walks through some of these, these comments and some of these attributes in much more detail. And please reach out to us if we can provide that to you. So, you mentioned, Brian, talking about AI and artificial intelligence. Again, I think private credit was somewhat exposed to that, perhaps, but I think the bigger takeaway is that AI really is actually causing some disruption itself. When we got together last, and we walked through our outlook for this year, we talked about the rise of capital spending devoted to artificial intelligence. And indeed, those estimates proved to be somewhat easy to jump over, and maybe a little bit conservative. In the sense, in the first quarter of this year, now guidance for overall capital spending has actually increased materially across the board, and certainly in the four companies shown on the screen here. Now, I think it's important to note that we as a group think that this is something that's notable, that's really been driving much of the economic activity for the past several quarters, but I think there's an important flexion point here in the sense that now, going forward, much of this spending will probably be financed via debt. So many companies up to this point have actually financed their build-out and the infrastructure associated with artificial intelligence from operating cash flow, which has been pretty solid. But at the point right now where this level of spending is… if it's continuing, essentially, will have to be dependent upon the debt markets, which is not really a bad thing by itself, but it does introduce a bit of risk going forward, if not monitored carefully. So, to jump along a little bit further in the conversation, I just want to spend a minute talking about disruption from within AI, and Steve, I'd like to get your thoughts on this in a second, too. But really, there was a big moment back in the early part of this quarter, the last quarter that just ended. that really we saw some significant advances in artificial intelligence, most specifically agentic AI, as it's known as. were essentially tasks can be formed by computers without much intervention from humans. And so, to some extent, that is really one of the catalyzing forces behind the disruption in private credit and other parts of the market as well, and indeed, we saw that most specifically amongst some software companies. Steve, if you don't mind, maybe just kind of walk us through your thoughts on what happened, and how you think about software going forward.
Stephen Hoedt [00:36:53]
Yeah, when you take a look at this chart, I think what stands out to me is that over the last 10 years, one of the most go-to defensive parts of the market has been the software stocks, because Defensive growth has been a place to hide in times of trouble. It was that way during COVID, it was that way during the economic slowdowns that we've seen. And this time, that's not the case, and it's not the case because these companies' business models are being disrupted materially. People don't know That 90% gross margins and dependable recurring revenue are going to be the same one year from now, three years from now, five years from now, where they have… have been able to hang their hat on that for the last 25 years. So. The fact that the stocks are down 35% so far, from peak to trough from last, say, October through the most recent lows. That… that looks like it is a… a repricing that, in our view, is not, is not crazy. It's happened for a reason. Like, the business models are not the same, the moats are not the same anymore. I would also point out that that bottom clip, I think, there's information content there, and that that's the relative performance of software relative to the S&P 500. And while we remain well above the 2022 lows. on an absolute basis in that top clip, we've made new lows on a basis relative to the S&P 500, and pay attention to the fact that we never took out the post-COVID highs in early 2021 on a relative basis. So, the market has kind of known, hey, something's going on with this software stuff. ever since the introduction of ChatGPT early last year, and even though the market made new highs and software made new absolute highs. the group never made relative highs, so I think that it's something to pay attention to here. And, you know, the fear in the market, and I say fear in quotation marks, and the reason why these private credit loans are problematic. Is because there is significant change going on here, and people don't know what the true, what the true value of these loans should be, and what the true state of software is going to be 5 years from now.
George Mateyo [00:39:20]
Along those lines, Steve, I think it is important to recognize, too, that there is some concern, perhaps, that AI could really displace a lot of workers, and a lot of jobs might be eliminated as a result of that. And I think that's really a big unknown, too, that's still out there, and that's gonna probably be a phenomenon for quite some time. Indeed, we think that productivity gains from AI could be quite significant, but maybe they could come later, and in the near term, we could start to see some, some increase in job losses. But if you widen the lens a little bit, and you look through the arc of history. Here's just a couple examples of certain jobs that actually were eliminated because of technology, only to find the fact that more jobs were created outside of that. So I think this is going to be one of those moments where, yes, there could be some pain and some disruption, but I think there'll probably be more benefits down the road And particularly from the sense of actually maintaining profitability and overall productivity as well inside the economy and the overall market.
Brian Pietrangelo [00:40:13]
Hey, Steve, before we leave this topic, we have a question in the Q&A. Could you just define defensive software for one of our listeners?
Stephen Hoedt [00:40:19]
Yeah, software has been a… has been viewed as a defensive growth area of the market. Defensive from the standpoint that they have a business model that has very high gross margins. Which means, you know, it doesn't cost a lot to produce a piece of software. You've got somebody writing code, and then you resell it. And then the fact is that the business models have had a high amount of recurring revenue. If you think about how you pay for your Microsoft Office 365 on an annual basis, it just renews and renews and renews, right? That is the same kind of thing. High number of seat volume, large amount of renewals on an annual basis. That makes the business models very sticky from a revenue generation and profitability perspective. And the fact that both of those things, both of those prongs, have come under attack by this AI disintermediation has kind of caused a complete re-evaluation of that segment of the market, which has been a defensive go-to over the last 15 to 20 years.
Brian Pietrangelo [00:41:24]
Thanks, Steve. Now, you're still up to go back to the big concept of what's happening in the market in general.
Stephen Hoedt [00:41:30]
And you know, when you take a look at this chart, you see the drawdown, peak to trough, in the bottom clip, the absolute price of the S&P 500 in the top clip. it does look to us like the market has been trying to roll over a little bit. This isn't something that has been happening, only since the Hormuz crisis has unfolded over the last month. the market peaked last October. We've not really had a lot of, upside as we've moved through. I mean, and our tech stocks peaked last October, the MAG7 did, and we've not had a lot of upside in the market since then. But at the same time, put all this in perspective, it feels like the market has had all this, crazy volatility, and we've fallen a lot, but we're only about… down about 5% from the peak right now, so… That's telling you that the market thinks that there's plenty of underlying positives that it doesn't really want to turn away from, and you'll see some of that when we go through some of the other slides that we have later in the deck. On this point, when you talk about volatility. We've seen a spike in volatility in the last month. We got upwards of 30 on the SIBO VIX, which is the volatility index from the Chicago Board Options Exchange. But, if you look historically, when you start to see outsized returns from spikes in volatility, it takes moves, say, 2 to 3 standard deviations or beyond. To… to generate a really great setup in order to put new capital to work and say definitively, hey, we're in a period of time where a quote-unquote bottom is in. We just haven't seen volatility explode to the upside during this most recent sell-off. I've remarked to colleagues that this has been too orderly for my liking. It's like we have this slow grind lower on an ongoing basis. And really, you kind of want to see things flush in order to decide, hey, that you want to step in, and we have not had that… that catharsis at this point. If you go to the next chart, Brian. And I'll further illustrate this idea that people are not panicked by taking a look at put-call ratios. So what you see in the bottom clip here is a 5-day moving average of the SIBO US equity put-call ratio. And typically, we see that move to over 1.1 on a rolling basis when there's panic in the market, meaning people are more than willing to step up and pay high premiums for puts relative to calls in order to put on a defensive hedge for their portfolios. And right now, we're sitting at .85. While that's above the levels that we saw coming into the new year at roughly .65 to 0.7, like, we're nowhere near 1.1. We're nowhere near the levels that say that there's panic in the options markets. So again. Sentiment here is not overly bearish. People are not bearish. Even though the market is off a little bit, we've never seen bearish sentiment creep into the market. Part of the reason we think that's the case is just take a look at what has happened with the red earnings line in the bottom clip. This is the forward 12-month earnings line for the S&P 500. It has literally done nothing but go up and to the right all year long during this period. We came into the new year at about $310 a share for forward earnings. We're now at $336 a share. So, over the last 3 months, we've added $25 plus in S&P 500 forward earnings. Now, as the market has sold off, we've seen valuations compress. That's what happens when you get the earnings line still going up, and stocks go down. That means the valuation has been improving, or getting… stocks have been getting cheaper. And we think it comes down to the simple maxim that we've talked about for a long time on these calls and other ones, and that is, as long as the earnings line is going up and to the right, it's really difficult for very bad things to happen to the market. So, yes, we've had a global geopolitical disruption here, but the bottom line is that earnings look great for the S&P 500 right now, and it's hard for people to sell stocks in that environment, irrespective of what's going on geopolitically. And you can take a… go ahead, George.
George Mateyo [00:46:04]
I was just going to jump in. Why don't we kind of move ahead a little bit to kind of talk about your specific sector use, and really where you find the most upside in the equity market right now?
Stephen Hoedt [00:46:13]
Yeah, we've had a little bit of a shift in our view year-to-date. Look, we've been along cyclical value, which is energy, materials. industrials, and banks within financials all year. That's been a good place for us to be in terms of our core equity strategy. I would tell you, though, that defensive growth, which you heard me talk about earlier with software, we were, we were modestly tilted toward that coming into the year, thinking that was an area that would be favorable, and that's also Things like, consumer services. communication services, all that kind of stuff, too. I would tell you that defensive value has kind of swapped places with our, with our opinion on defensive growth so far this year. Healthcare is looking good, consumer staples look good, utilities look good. We think that the market basically is calling out for kind of a barbell approach, where your long cyclicals via energy, materials, and industrials and banks and also long defensive value in terms of consumer staples and healthcare, and the one thing that all of these things have in common is this halo market, which is hard assets and low obsolescence. They're… they're insulated from the whole AI theme, so… In our view, the market has really kind of moved into this idea of, you know, we know we can count on these business models to deliver going forward, so we're going to focus there. And we've kind of gravitated toward the same approach in our strategies.
Brian Pietrangelo [00:47:51]
George, it'd be a great opportunity to talk about uncertainty and some closing remarks as we get close to the top of the hour.
George Mateyo [00:47:59]
Yeah, Brian, thanks for that, and thank you too, Steve, for your insights and the way you've navigated a really interesting environment, to say the least. So, again, if we wind the aperture just a bit, I think it is fair to say that we are obviously in the period of immense uncertainty from many, many fronts. But if I go back and look at just uncertainty relative to where we've been, it's quite interesting to see that we're actually at levels now that we haven't ever been before, and this was actually just a measure of one barometer of uncertainty, and you can see, relative to today, we are actually, according to this level of uncertainty anyway, in a more uncertain time than we were relative to things in the middle of the pandemic. And that, to me, is a little bit hard to understand, but nonetheless, we are still grappling with a tremendous amount of ambiguity and uncertainty. That being said, when we think about uncertainty, though, we've provided a few thoughts here on this slide to talk about how we might be able to cope with that. I'm not going to read these for you verbatim. But I do want to acknowledge that the fact is that uncertainty is always prevalent, particularly when it comes to the future, right? We just don't know exactly what we don't know, and if you at least acknowledge that, that to some extent allows you to free yourself About things, and focus yourself on more important things that can have a bigger impact. We often think about things in a matter of probabilities, not predictions. So, for example, we don't intentionally put together point forecasts on certain indices or interest rates, but instead we think about a range of outcomes that could be more instructive for us to think about how to put capital to work. And also, I think, lastly, it's important to recognize, Brian, that we shouldn't focus… we should be focused on, frankly, the things that are important. And the things we can control. We can't predict the future, we can't control either, but we can't control how much risk we put into our portfolios. We can control how timely our investments are, in other words, how long we actually want to maintain those investments. We can certainly control our asset location and our asset location, so where we actually put assets is important as well, and we can certainly control our reaction to uncertainty as it manifests itself as well. So, lastly, just to close out some thoughts, I think it is fair to say, in terms of where we might go from here, as we've said before, as this crisis first started to manifest itself and become evident about 33 days ago. We acknowledge that stocks will probably stop sinking when oil stops spiking. And in our view, oil is likely to peak, but then slowly recede from here. It could go further higher, perhaps, but we just don't know. But nonetheless, once things become a little bit more clear, as we've seen in the last 40 hours or so, maybe we might start to see some type of bottom in the overall equity market. And indeed, if we look over periods of time, when we have these periods of geopolitical instability, oftentimes markets are volatile in the short term. But over long periods of time, as we've acknowledged before, markets tend to settle up. They don't settle down, they settle up, meaning at some point, markets clear the uncertainty, and markets tend to revert higher over the long period of time. And so, again, just to close out where we started, Brian, I think it is fair to say that these are one of these times where weeks are happening, and periods of decades, and vice versa, meaning essentially what's happening right now is happening at unprecedented speed. We also have to acknowledge that volatility, notwithstanding as being quite elevated, we see markets actually performing as we expect they would be. We expect some volatility to continue, and we expect more uneasiness with respect to overall Prices of energy and prices of oil, but things should settle down at some point, and when they do, we'll probably be left with modestly higher inflation. And modestly, it's lower growth, but hopefully we won't actually experience a recession, and hopefully corporate profits can maintain their level that they've been at. And as Steve pointed out, should that continue, that's a powerful backdrop for, for equities in general. Now, I think in terms of longer-term outlooks, we do suggest and we do think that there probably will be some homeless premium placed into the price of oil, meaning it would probably be unlikely that we would see the price of oil fall back below where it was a month ago in the near future. We also are very wide-eyed about the fact that what could happen in the least is still very important. It's also subject to a lot of volatility and a lot of fragility, frankly, that is not behind us. We also want to acknowledge that there is uncertainties in other places, too. We talked about some of those today with respect to artificial intelligence. We talked about private credit for a minute. We also acknowledged that there are changes at the Federal Reserve that Rajiv talked about that could also provide some instability going forward, because frankly, we just don't know exactly what would happen with respect to central banks in the future as well. So, all of that said, Brian, I think it's important to recognize that investors, in our view, should really be embracing new approaches to portfolio construction. We've long argued that real assets, for example, can provide a meaningful diversification tool inside a portfolio. We also think that international markets provide some diversification too, and we also think that things like alternative strategies, where appropriate, can provide some boosts and some benefits to diversification overall as well. Again, we're really against the idea of market timing, but instead, we really think it's important to use these times of volatility to strengthen and enhance your portfolio from the perspective of diversification. So with that, Brian, I'll turn it back to you to see if there's any lasting questions, and again, appreciate everybody's attention this afternoon, and thanks for joining us.
Brian Pietrangelo [00:53:02]
Thank you, George. We do have a couple closing remarks. The first one is, with regard to content, our Chief Investment Office here at Key Wealth does continue to provide a lot of content available on Key.com. One of those pieces is called our Key Questions Article Series, which is available on Key.com, and also our weekly investment brief. which is available on Key.com, in addition to a podcast, if you want to listen in to us on a weekly basis. In addition, just to make sure everybody knows, this deck and slide deck is available along with the recording of this conversation today. If you want either, please reach out to your KeyBank representative, and they can forward you on that information. I did want to end by saying, as about 14 days ago, when we decided to queue up this webcast, we thought it was very important, given the market and geopolitical volatility, to have this call for our clients and for our investors. We did have a challenge, though, that we knew that this week was going to include multiple religious holidays, and we want to be very respectful of that. With regard to many of them happening this week, and at the same time, providing that balance with picking the date. We wanted to make sure we could insert it in today, and then finish by 4 as… by 5, I should say, given that the market closed at 4 p.m. today, we wanted to have the call right around then. So, by all means, thanks to everybody. We appreciate the engagement in the Q&A session, and this does conclude our webcast for today. Thanks, everybody, and happy holidays.
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Key Takeaways:
In a time of heightened uncertainty, this conversation offers perspective and practical guidance to help investors stay grounded and confident. It brings focus to three forces shaping today’s environment and the signals most worth watching next, including:
Iran and geopolitics: Conflict-driven headlines can create short term volatility, but the most market-relevant pressure point centers on energy disruption risk tied to the Strait of Hormuz and what that implies for inflation and growth. The emphasis stays on diversification and avoiding emotional, sudden portfolio moves during fast-changing news cycles.
AI disruption: Rapid advances in AI are influencing growth expectations and capital investment, while also disrupting established business models, especially in software, with spillover concerns into areas like private credit. The takeaway is a more selective environment where durability and resilience matter.
Inflation, Interest Rates, and the Fed: The next market turning points hinge on whether inflation pressures persist, particularly as energy filters into prices, and how financial conditions respond. Key indicators highlighted include inflation trends, bond market demand amid heavy Treasury supply, and uncertainty tied to Fed leadership transition and communication.