JACK JANASIEWICZ: My name is Jack Janasiewicz I'm lead portfolio strategist here at Natixis Investment Managers and also a portfolio manager on the strategist models here at Natixis Investment Manager Solutions.
BRIAN HESS: And I'm Brian Hess, investment strategist. Welcome to Tactical Take. Jack, before we recap this past year and look ahead to 2025, let's touch on inflation briefly. There are rumblings it might be accelerating. The most recent CPI report had some elements to it that showed stronger prices.
We have the looming tariffs potentially next year, which could put some upward pressure on imported prices. And so I'm wondering, do you still think that in the US we have inflation heading back towards the Fed's 2% target, or are we possibly stalling out here above target, with the next move likely to be a re-acceleration and higher growth of prices?
JACK JANASIEWICZ: Yeah, and that certainly seems to be one of the risks that's been popping up more recently in the marketplace. And if we look at the more recent core CPI prints, you've had four straight prints of a month on month increase of 0.3%.
BRIAN HESS: And as an annual rise to 2%.
JACK JANASIEWICZ: I was just going to say, annualized that, you get the 3.6%. So certainly, I can understand some of the concerns in the marketplace-- same thing with core PCE that's been firming up, as well, rising to 2.8%. And obviously, core PCE is the one that the Fed's more in tune with.
But I think if you look at the more recent print, there's a couple of things that's worth highlighting in there. And what we're seeing now, rent and owners' equivalent rent really are starting to come down finally. And that's been something we've been waiting for quite some time.
And if we look at that last core CPI print, rent and owners' equivalent rent was inside of 10 basis points in terms of its contribution to that core CPI print. And that's basically the lowest we've seen since April of 2021, so moving in the right direction there.
And when you think about the shelter component in core CPI, that is north of 40%. So if have that disinflation trend that's impacting 40% of the basket, that's going to be a pretty significant tailwind to seeing it pushing lower. So that's one thing to think about.
And the other one, too, we're seeing some quirky numbers that are popping up, some quirky underlying themes that are probably more idiosyncratic than trend related to inflation. And a couple of things worth noting here. The first one, big jump in household furnishings this past release-- spiked 0.7% after basically been in deflation for 15 of the last 19 months.
BRIAN HESS: It's not like we have a resilient housing market, so it doesn't make sense that we should have strong price pressures.
JACK JANASIEWICZ: Exactly, so a lot of quirky things. Another one to say there are lodging away from home, jumped 3.7% for the month. We look at some of the ancillary data, we don't really see that sort of strength playing itself out in that segment of the inflation basket.
And then the last one, things like club fees, so think about golf course fees, your gym memberships, those sorts of things, that jumped suddenly 10x versus what we've seen on average over the last three years. So, a lot of weird things that, to us, are more idiosyncratic-- not a signal for a true shift in the underlying trend.
And the bigger takeaway is that we're finally seeing that shelter component heading down. And I guess the last takeaway here is when you look at CPI, PPI, and you put all those things together, you can kind of back into what PCE would look like. we're expecting a 0.13% increase on a month-on-month basis for the print coming up over the next couple of weeks here. That translates into a 1.57% annualized.
So, there you go. So that's the key, I think, in here-- so disinflation in some areas, inflation accelerating some weird places. But the bigger trend shelter heading lower. That's the one I think we're going to focus on more. And so yes, we still think we're heading towards that 2% target.
BRIAN HESS: OK, great. Yeah, the housing components just have such large weightings within the inflation metrics that they can move the needle so much relative to some of these other smaller figures you talked about.
JACK JANASIEWICZ: Yep, exactly.
BRIAN HESS: So that'll be good for the Fed if that continues to move in that direction on OER. All right, well it's the last episode of the year, so I figured with that, we should probably look back on 2024 a little bit, maybe a report card.
We had three major themes that we've been highlighting all year. And I think in our May episode of Tactical Take, we actually sort of did a mid-year recap. So now that the full year is mostly behind us, let's go back and look at them. We'll take them one by one.
First theme was that-- and you did pretty well, I have to say, as sort of like a teaser here. First one, growth would not decelerate precipitously.
JACK JANASIEWICZ: Yeah, right. And I would argue that we're even probably a little bit surprised at how well growth has held up in here-- probably more resilient than we've anticipated, so even better than our optimistic outlook.
BRIAN HESS: So that was one. We'll give you an A for that one. So the second theme was that it didn't really matter when the Fed would start cutting rates or necessarily how many cuts they delivered, but just the fact that there was no longer a risk of them hiking further and pushing us into a recession. That would make all the difference for markets.
And so I think that, too, has played out pretty well, because if we look at what's priced for the Fed today and what they've actually delivered, it's a lot less than what we were thinking we might get a few months ago or earlier in the year. And yet, markets have been resilient and growth has held up, like you highlighted. So I mean, that, too, I think was an excellent call and particularly with respect to the US stock market.
JACK JANASIEWICZ: Yeah, I mean, we were thinking at one point during the summer, what, 10 cuts between then and the end of 2025.
BRIAN HESS: Basically.
JACK JANASIEWICZ: Now we're down to about three. And we're expecting one coming for December. So you're really only two for next year. Yeah, so to your point, the market has done very well pricing out anywhere from 7 to 8 cuts. And here we are, pushing all-time highs again.
BRIAN HESS: And it's probably Thanks. To the third theme that we've had the market hold up, which was that earnings would drift higher as a result of growth holding up and as a result of the Fed not hiking any further. And I think that's what we've seen. You've been pointing to S&P 500 earnings estimates, which have even now continuing to drift higher.
JACK JANASIEWICZ: Yep. And I think the other key there is simply margins. We continue to hear from the bears over and over again that margins are going to have to basically compress. And we're actually not seeing that. We're seeing just the opposite. Margins are continuing to march to all-time highs. And so that operating leverage is a huge bonus to that bottom line. And that's, I think, another key factor here.
BRIAN HESS: So you were 3 for 3. Good job. We like to see that.
JACK JANASIEWICZ: Calling it right now-- I'm done. Retire.
BRIAN HESS: We're going to ask you about next year. And unfortunately, you're not going to be able to just ride on this one for forever. But, all right-- so sticking with this past year, though, how about any surprises. What are the things that maybe you didn't expect that happened?
JACK JANASIEWICZ: And we talked about one, how resilient, really, the economy has been. We certainly expected growth to be better than, I think, most people were expecting coming into the start of this year. But it's even been more resilient than we thought. So, I think that's the first surprise that we would talk about.
But again, iterating off of those three themes that we just talked about, the simple fact that we didn't have a 10% drawdown in the equity market this year looking at the S&P 500, I went back and looked. I think the biggest drawdown we had was in July, August, where you had close to 8.5%. But a proper correction of 10% is pretty typical, even if you are in a bull market. And we just didn't get that. So, the fact that we haven't had a proper 10% correction for quite some time, that's pretty impressive, as well.
BRIAN HESS: So, the vol compression, that would maybe be one surprise.
JACK JANASIEWICZ: And that leads us to maybe another one to bring up here is volatility. When you look at 30-day implied volatility-- so obviously talking about the VIX here for equities. But if I just look at the 30-day implied volatility on the ETF for TLT, so the 20 plus duration assets there, that's actually been higher than equity vol.
So, the fact that you have the bond market exhibiting a higher implied vol than the equity market, that's kind of interesting. And so I guess you can make a case for that because you're at a certain inflection point. You didn't know where inflation was going. The market was concerned about potential recession risks.
So, you're swinging from the market pricing in 10 cuts to 3 cuts because the growth outlook is shifting pretty dramatically. Concerns about the fiscal deficit when you start talking about the election cycle. The list goes on and on there. So it's not surprising that there's volatility being reflected in the Treasury market because of these uncertainties. But the fact that equity vol is still doing a lot better than treasury vol, that's pretty impressive, as well.
BRIAN HESS: Yeah, probably not something that happens a whole lot. I mean, we'd have to go back and look at the spread there. But I think it's probably typical for the VIX to be running higher than long term Treasury vol.
JACK JANASIEWICZ: Yeah, exactly. And then maybe the last one on the political front, just the red sweep. We certainly-- we listed out the potential outcomes there. A red sweep we didn't have at 0 in terms of the percent probability. But we also gave it a low probability event, as well. So caught us off a little bit in terms of thinking about what would be a surprise on the political front. So that red sweep, I would throw in there as well.
BRIAN HESS: I think by the time the election actually arrived, the market pricing had swung to such a large extent that it opened a lot of people's minds to the possibility of it happening. But yes, if we did this poll back in May or something, it would have seemed like an unlikely outcome.
JACK JANASIEWICZ: 100%, yep.
BRIAN HESS: I think for me, one of the big surprises was the resiliency of the US consumer when we think about there has been some slowing in job creation, and wage growth has slowed a bit. And people talk about the COVID savings being depleted, maybe not eliminated.
And yet, despite all that, the consumption contribution to GDP accelerated all three quarters that we've had so far, to the point where I think in the most recent quarter, it was a 2.4% contribution to overall GDP growth. That's just consumption.
If the whole economy grew 2.4%, that's a pretty good quarter. So I was surprised by that. And it will be interesting to see if that consumer momentum can hold up as we move into 2025.
JACK JANASIEWICZ: Sure. And like you said, that's the linchpin to the economy and something we continue to monitor, because if we start to see some fracturing in the labor market, some softening in the labor market, it's going to show up in the consumption numbers at some point. And that's going to be a big drag to the economy. So the number one thing, I think that's the key to the bullish outlook, the health of the consumer. And they're going to continue to consume.
BRIAN HESS: Yep. OK. So that's a good segue into thinking about next year in 2025. So, we covered the themes of 2024, which were good calls. How about next year? What's on our minds for 2025?
JACK JANASIEWICZ: This gets tricky because there's still, I think, a lack of visibility going forward with regard to some of the Trump policies as we start to go into the new year. And I know when you're on the campaign trail, you're obviously going to say things to get elected. But when it comes time to actually governing, there's some headwinds there that you're going to run into.
And I know yes, we do have the red sweep. So he's got Congress is going to be in his favor. But I still think there's still some things out there that we still need certainty on. And tariffs are going to be a big one.
We've heard certainly from Scott Bessent about maybe we're going to implement them a little bit more gradual. But again, we still need to see how this actually plays out. So that uncertainty makes the forecast for full year 2025 I think a bit tricky.
But I will say maybe the one thing that we have some conviction on is basically the idea of US exceptionalism. And I think that's fairly consensus out there. And I think that's we're falling in that camp that probably persists for some time. And why is that?
I think maybe this is where we have a little bit of a different take that not many are talking about. But it's still, I think, the difference between what we're seeing in the US relative to everybody else comes down to a few things. One of them is productivity growth.
And what's the origins of that? I think a lot of that has to do with how we addressed the pandemic. In the US, we sent out stimulus checks. And those stimulus checks gave you the ability-- in some cases, could pay off your debt, save it, go on and on how we did it. But also basically gave people the potential to go out and start a new job, a new company.
And so when you see those new business starts, it was pretty significant. And I think that, in itself, fosters that sort of productivity gains. But we also saw job hopping during the pandemic, as well. The best way to increase your income was to jump to a higher paying job.
And in some cases, jumping to a higher paying job is probably something you wanted to do. And now that you're sort of in that seat and you're earning a higher income and you're getting comfortable, you've been in that seat for a while. You're getting good at what you've been doing. You're getting more out of what you're doing at your job, so to speak.
JACK JANASIEWICZ: Exactly. Those things, I think, we're starting to see the benefits accrue. And then the last piece would be you had to invest in technology during the pandemic. If you didn't have a web presence, you probably weren't going to be able to stay in business because you had to basically service yourself through online shopping, that sort of thing.
But I think those investments that we had seen in technology over the last couple of years are starting to manifest. And we're sort of seeing that in some of the things with regard to AI investment, for example. I was blown away by going through the transcripts for third quarter, how many companies mentioned AI and the benefits they're starting to accrue. So maybe we're just starting to see that.
But put it all together, these things are net positive for that productivity backdrop. Think about what Europe did. Europe didn't send out stimulus checks. Rather, Europe basically said-- asked companies to retain your employees-- so a little bit of a different response to the pandemic. And we're seeing that because just by having people retain at their current positions, you don't see that accrue necessarily to productivity gains.
So that's giving a huge leg up to the US economy. You're doing more with less. That basically gives you the ability to run a higher GDP and it be not inflationary. And again, that's accruing to the bottom line for a lot of these companies helping with the margins. And so I think that is one of the key pieces that we keep talking about.
We're seeing more signs of that coming due in the numbers that we're seeing from earnings. We expect that to persist into 2025. And I think that's going to be a key differentiator as to why US probably continues to outperform, both from a growth perspective and from an earnings perspective.
BRIAN HESS: And that has implications for macro markets too, because to the extent that the US is outperforming on growth, that means maybe a higher R star in the US, a higher policy rate here. We're seeing a big spread now between US rates and German rates, for example.
And then that supports the dollar. So you've got this story of the dollar strong, US yields are higher. That's a virtuous cycle. And then it supports US equities because people want to buy those equities priced in US dollars and where they're enjoying the earnings growth.
JACK JANASIEWICZ: Yeah. And I think another thing to think about, too, in here, how does this maybe change? What's the risk to that sort of call? I think a lot of it hinges on two things. One, you need probably a more aggressive ECB. If we think about the European economy, we call it a two-staged economy, core Europe, much more manufacturing driven. So they're going to be much more interest rate sensitive or peripheral, much more services, tourist oriented.
The peripheral Europe was actually doing pretty well because of the tourism factor, the services factor. But if you start to see the ECB cutting more aggressively, that probably helps to stimulate the core of Europe, the manufacturing base. We're still a little bit unconvinced that the ECB is going to cut aggressively. But that's a risk to this.
And I think the other one is basically the China story. And if we start to see an aggressive stimulus from China that basically gets growth not just to put a floor under growth, but see it re-accelerate, I think the key beneficiary of that will be core Europe.
We've seen plenty of fits and starts here with the idea of fiscal stimulus from China-- a lot of talk, but not a lot of action. So again, still a little bit hesitant on that backdrop. But those are the two things I think maybe where that US exceptionalism is at risk and how we might see things shift.
BRIAN HESS: Yeah, that makes sense. So the one thing that could make US exceptionalism take a back seat would be if China really came out and stimulated aggressively, like in 2009 or 2016 or something, and we got that big global upcycle that would take some of the pressure off these currencies, allow central banks outside the US to not have to cut so much and have higher interest rates. So that's something to watch out for.
And I guess with that, we made a trade in our models recently on this idea of Chinese stimulus when they rolled out their initial change in tone and the stock market surged. In response to that, we decided it was no longer a good idea to be underweight EM equities.
They're cheap, there's kind of no denying that.
Earnings growth has been very disappointing over the past decade. But they are cheap, and it can be dangerous to be underweight or effectively short, something that's so undervalued. So we covered that. And we're neutral with EM.
So I'm going to transition now for our last topic into our model positioning a little bit. Is that what you'd be looking for to get more overweight EM equities, meaning a stronger Chinese policy response? And for now, I guess we're happy to just stay at neutral. Is that right?
JACK JANASIEWICZ: Yeah, I think that's the key. And my background comes from emerging markets. And I always learned that the weekends belong to the government and, to a lesser extent, to the central banks, because they love to announce policy changes over the weekend. And you come in Monday morning and everything's limit up, so to speak. So where there's smoke, there's fire.
And when you hear these rumblings, there's usually something that ends up following through on the back of that. So with regard to the Chinese story and the potential for an actual stimulus package, that is pretty significant. We look at it as the upside, downside risk skew.
And from that perspective, a lot of bad news has already been discounted in Chinese equities. So the potential for a disappointment and really seeing the bottom fall out of Chinese equities, sure, it can happen. But I think there's a lot of that discounted.
BRIAN HESS: They're a lot to play for on the downside.
JACK JANASIEWICZ: Exactly. So for us, the upside is pretty significant. So that risk to us was, hey, let's cover up our underweight in emerging markets and flatten that out. So if we are wrong and we do see significant Chinese stimulus package coming, we're not going to get burned on the back of that.
And push that out to where we're talking about with regard to European equities, that's a tangent knock on effect we just talked about. But I also think the outperformance that we've seen from the US over the last couple of weeks in here has been pretty significant.
And we look at that relationship from a standard deviation basis. And you're getting out there for multiple standard deviations for that relationship between the performance of US markets and European markets. There is, I think, a little bit of mean reversion that comes back into the marketplace.
And so again, it wouldn't be shocking if we get a little bit of a rotation going into the end of the year to start the next year, some repositioning in the markets, people selling their winners, buying their losers, which would mean selling some of your US equities, some of the Trump trade, for example. And putting that back into the laggards, in this case, would be European equities.
And so just trying to play a little bit ahead of that. So again, purely a tactical position here for the one to two month outlook. And we just expect a little bit of catch up with regard to that trade because it's been so stretched more recently.
BRIAN HESS: So we're pretty close to neutral on international equities overall, because we bought FEZ, EURO STOXX 50 ETF, as I think our most recent tactical trade. And that focused on covering that European underweight for those reasons you cited, probably likely to be more of a short-term opportunity, though, than what we did with EM, where we can imagine staying neutral for a longer period of time and maybe the next step even being getting overweight.
JACK JANASIEWICZ: Correct.
BRIAN HESS: All right, great. Now, with stocks overall, I think we have 4% to 5% of an overweight across models, depending on the risk tier. Still comfortable being overweight stocks for now?
JACK JANASIEWICZ: Yeah. We've spent a lot of time thinking about 2025. And one of the things, the foundation for how we think about it really, if you look at presidential cycles from a seasonality perspective, that first term, that first year of a new president, you tend to see decent gains in the equity market.
Most of those tend to be front loaded, though. So first half of the year does pretty well. Second half you get a little bit more chop. So I think as we head into the beginning of next year, there's still a supportive backdrop. You still have the potential for animal spirits to be unleashed.
The Fed's still probably being accommodated with maybe two cuts at some point in the first half of the year. So I think the ground is set to be supportive for risk assets. I wouldn't be shocked if we finally do get a proper correction in there, but I think this is the end of the bull market.
So as we roll into 2025, that overweight, I think, still makes sense. We still think it's a risk on environment. And obviously, as we start to push further into the beginning of 2025, we'll reassess, because things are going to be changing pretty quickly.
BRIAN HESS: Absolutely. So for now, we're comfortable. But who knows? Come January, if we start to worry about profit taking after the end of the tax year, that could be a reason to maybe cut back a little bit.
JACK JANASIEWICZ: Absolutely.
BRIAN HESS: And then lastly, on fixed income, we're fairly neutrally positioned in bonds and across the whole fixed income book, a little bit underweight duration, slightly underweight duration. And we still have the emerging markets US dollar ETF, which is it's government bonds issued in dollars in the emerging world.
Anything you're looking at on the fixed income side that might be interesting? I mean, spreads are really tight. So it does not seem to be much opportunity.
JACK JANASIEWICZ: Yeah. And I think this year is going to be largely-- or I should say, next year is going to be largely a carry environment. I don't see a ton of movement in spread. Maybe we do grind a little bit tighter. But to your point, when you look at where we are with regard to spreads and high yield or investment grade, historically tight. So I don't how much more upside there is.
So maybe we get a couple of basis points in investment grade and maybe get 10 or 20 in high yield. Is that going to be the primary driver? No. It's probably going to be still carry. And given the fact that the 10 year still is sitting at 440-ish, you're still getting a decent all-in yield.
But we still think the 10 year probably remains in a range trade. Because if you think about what's the potential for rates to go below 4, let's say, you're probably going to see the Fed react as such. Because for that sort of a trigger, you're going to see probably a labor market weakening.
And so that probably puts the Powell put back in play because the Fed will respond to a weakening labor market. I would also say if the economy starts to slow, you're going to have a president that really has one eye on the stock market. So you could also argue there's a Trump put in there. So probably, that puts a floor underneath growth, which probably puts a floor underneath how tight yields can fall.
And on the other side, if you see yields backing up to, say, it's over 5, you're probably going to have the market throw a tantrum about that. You're going to see equities probably sell off and then the potential for that reverberating through into slower economic growth. You're going to have that self-governing mechanism, which probably puts a lid on terms of how high up yields—
BRIAN HESS: And that comes [INAUDIBLE]
JACK JANASIEWICZ: Exactly.
BRIAN HESS: Gets the sell off.
JACK JANASIEWICZ: So I think you're probably in a range trade, which means for fixed income, you're going to earn your carry. And again, back to our positioning in the portfolio, overweight equities, we want to have a little bit of equity risk offset in case we're wrong on that front. And that's going to be in treasuries. So a little bit of a favoring towards the treasury side of the equation. But that's more just from a risk management perspective because we're overweight equities.
BRIAN HESS: Right. It provides that hedge. And we're not really getting paid too much in corporate credit anyway. One area in fixed income that could be interesting-- this is not a forecast, but we talked about the potential for a stronger Chinese policy reaction. Since there's not much room for corporate credit to compress or spread product in general in the US, you could see global fixed income as an area of opportunity if the dollar were to weaken.
I mean, we do have the euro around 1.05. We have something like the Aussie dollar at $0.64 and then a lot of emerging market currencies that have sold off quite a lot. The Brazilian real above 6 with very attractive yields. So that's an area I think we'll keep on the radar, too, if the cards align.
JACK JANASIEWICZ: Sure. And I think, oddly enough, there are some pretty good, I think interesting stories that you can start to play with on the back of fixed income over there. Because if you actually do get a slowing of the international backdrop, you're probably more apt to see rates rallying, as opposed to in the US, you're probably going to actually come into a floor there.
So you actually, I think, have a little bit more potential upside for yields to fall in capital appreciation on the fixed income side, as well as the currency returns, as well.
BRIAN HESS: So you can get the carry plus a bond return if yields fall, plus the FX return, which is a powerful combination.
JACK JANASIEWICZ: Yep. 100% agree.
BRIAN HESS: All right, well, thank you, Jack. Happy holidays. I look forward to continuing the dialogue next year. And thanks to all our listeners. See you next time.
