Market Outlook

Amy: Hello, everyone. I'm Amy Thomas, a strategist here at First Citizens Bank. Today is Wednesday, December 11, 2024. I'm joined by Phil Neuhart, director of market and economic research, and Brent Ciliano, our chief investment officer. And I want to welcome you to our monthly Making Sense series. This is our 2025 market outlook, where Brent and Phil will highlight their thoughts going into 2025 and beyond.

As always, the information you're about to hear are the views and opinions of only the authors at the time of recording and should be considered for educational purposes only. This information should not be considered as tax, legal or investment advice. If you have any questions or concerns about your financial plan, please reach out to your First Citizens partner. And Brent, with that, we're ready to go, so I'll turn it over to you.

Brent: Well, thank you, Amy, and good afternoon, everyone. Hope all of you are well. Phil, I can't believe it, 2024 is basically in the books. Where did this year go? Time flew.

Phil: It really did fly by, absolutely.

Brent: Well, the good thing is that at this time of year, we have the time to sit back and reflect a little bit, maybe prognosticate a little bit about some of the topics and themes that will affect markets and the economy in 2025 and even beyond.

So what Phil and I decided to do for this year's outlook is break down our views into five main themes. Phil, we could have easily done 25 themes for '25, but then we certainly wouldn't get through all the content. But these are the five themes that we think are truly going to affect the economy and markets next year. So let's systematically go through that.

The first one is, we think, number one, Phil, that fundamentals really, really matter—as you and I have been saying for many, many webinars. But again, are they still in place? So let's kind of go through that broad economic mosaic.

I think the other thing that we've been talking about for a while is this theme that the Fed may deliver far fewer cuts than what was priced into the markets before the Fed started on the rate-cutting campaign. And we'll kind of talk about where we are from there.

Phil: Additionally, when you look at, you know, this incredible run-up in risk asset prices we've had in recent years, we expect lower future returns from here. We'll dig in on that, and nothing to be fearful of, but lower expected returns considering how great returns have been. And to that point, portfolio balance and broad diversification are critical. We want to spend some time there.

Brent: Always has been critical.

Phil: And then, as always, we want to spend a little bit of time on market tenets to remember. Some things we want to remind you as we enter the new year.

Brent: So before we do that, though, Phil, before we get into those themes, I think it makes sense for us to critically look back at 2024. And let's start, first of all, with that broad economic picture. And let's start in the top left and talk about broad economic activity and US Real GDP growth.

Consensus economists believed coming into this year that our economy would only grow at about 1.3%, which would have been a significant comedown from where we were in 2023. But here we are sitting in December, and expectations are for 2.7% growth. So there's more than a doubling of expectations.

So again, the US economy has proven significantly more resilient than what economists thought at the beginning of the year. And one of the reasons for that in the next box over is our incredibly robust labor market. Again, economists had thought that we would see a pretty significant reduction in job creation this year and only 74,000 jobs created on an average monthly basis. And again, defying expectations, we are now at about 190,000 jobs on average, year to date. So again, a robust labor market that continues to be strong.

Phil: And when you have this sort of hotter-than-expected economy, what does that yield? It yields inflation. So in the upper right, consumer price index—expectation coming into the year was 2.6%—so above the Fed's target. We came at 2.9%. That's higher than expected. Not shockingly higher—but higher, which you should expect when you have hotter-than-expected economic growth. What does higher-than-expected inflation yield? Well it yields higher rates.

So when you look at the fed funds rate in the lower left here, expectation was for a lot more cuts this year than we ended up having—3.8%—versus the expectation for end of the year of 4.5% on the fed funds rate. Why is that? The Fed, of course, has to keep inflation in mind as part of their dual mandate. Similarly, recession probability coming into the year—the consensus had a 50% chance of a recession this year. Now we're at 25%.

So when you look at this holistically, what does it speak to? It really just speaks to a better-than-expected outcome, right? You have more growth, a hotter labor market that yields more inflation, higher rates and of course, lowers recession probability.

So as we flip ahead, what happened in terms of markets this year? As has been a trend for a while now, the US was the best house on the block. Really exceptional year-to-date returns—over 25% through December 9th—as you can see here. International development and emerging also performed, good years, but nowhere near what US equities performed.

And then fixed income on the right side had a volatile year, right, and we'll talk about rate volatility in a moment. But on net through December 9^th, you do see positive returns in both aggregate fixed income and muni bonds as well.

Brent: Which is great for balanced portfolios to see all those bars going in the right direction. So if we get underneath the hood a little bit more on the next slide, Amy, and we talk specifically about US large-cap stocks, and we're looking at the S&P 500 Index here, right. Over the last 2 years—so from January 2nd of 2023 to December 9th—we are up cumulatively 63% in the S&P 500. What an incredible run. And as you can see, certainly not a straight line up, and we've had some fits and starts, and we certainly had, you know, the drawdown at, you know, in the fourth quarter of last year, sort of that time frame down, but a significant run up.

Year to date, what's incredible is we're up more than 29% year to date through December 9th. But the thing that's incredible is we've hit 60 all-time-highs this year, which is just incredible. So again, from a cumulative perspective, either year to date or over the last 2 years, US stocks have been an incredibly robust story.

Phil: Exceptional returns.

Brent: Yeah. So from a fixed-income perspective, what we're looking at here is the Treasury yield curve. And certainly, you know, you and I have been talking about this for quite a while, one of the byproducts of market participants changing their expectations on the path forward of monetary policy, which we'll cover in a second, has manifested itself in rates volatility.

This is the Treasury yield curve, folks, just this year. Incredible volatility, right? The dark blue line is the highs that we saw back at the end of April. The light blue line is the lows that we saw right before the Fed September meeting. This bar's line is September 16th. The gold line is where we are today at December 9th. And what you can see here is that we've seen significant volatility. Ten-year from high to low, more than 110 basis points of move. Two-year, 140-basis-point move.

And what I really want you to focus on is from the light blue line to the gold line. We've seen it in investment terms what we call a bear steepener where sort of intermediate out, we've seen yields rise and the short end of the curve fall. And right now, we don't really have a yield curve. We have a yield streak. And I think one of the things, if we were to look forward into 2025, I think we see more of this. I think specifically when we think about the path forward for monetary policy, we do think that that's going to manifest itself in continued rates volatility going forward into the new year.

Phil: Yeah, uncertainty around monetary policy drives rate volatility, and we've—as we'll allude to later—had a lot of change in expectations around the Fed. What does that do? It moves around the yield curve. So it is all tied together.

So let's jump into our five themes. First, fundamentals. Are they still in place? Not to skip straight to the takeaway, we think generally they are. But we want to spend some time on what we are watching.

So on this first slide, we have payroll job growth on the left side. This is a chart we've shown for a few months now. It's really important. We're smoothing payrolls, right? And remember, we had some volatility due to hurricanes, really tragic events in our home market. But we are still seeing payrolls slightly above that break-even level. The break-even level is where you need to see payrolls to not see the unemployment rate move dramatically.

So we are still seeing decent job gains off the extreme highs we saw after the pandemic. But again, that was distorted from huge layoffs in the first year of the pandemic. On the right side, the unemployment rate has risen from the lows of last year, 3.4%. But what's interesting on that dark line, you see a small little sideways move. We've been in the range of 4 to 4.3% since May.

Brent: Yeah.

Phil: So we've talked a lot about when the unemployment rate starts rising, it tends to continue to rise—and pretty sharply. That is not playing out right now. So is this the soft-landing scenario? We certainly hope so. But it does give us some solace that we are seeing a sideways move in the unemployment rate. But when you ask consumers—net share of consumers reporting jobs are hard to get—that has moved up. Now it came from the lowest level on record, right? So it's not as if we're coming from a place of weakness, but jobs are getting somewhat harder to get. This is something to watch. We are seeing normalizing in the labor market. The question is, does it turn into weakness? Not yet, but something we are watching very carefully.

So what about the inflation picture, as we flip ahead? Something we get asked a lot. When we're on the road, inflation is very much on our clients' minds. And there's a lot of frustration around inflation—and frustration with people like us. Because we say things like, well, inflation is moderated to a range of 2.5 to 3%.

Brent: People shook their fists at us.

Phil: That's right. But no one pays that rate. They pay a cumulative rate, and we've had a lot of inflation in the last few years. So what are we looking at here? Let's just go in order of the legend. So the inflation rate are the bars, right, and you can see we had, of course, astronomical inflation, multi-decade high, near-10% inflation. That has come down to roughly 2.5%, depending on the measure you use on trends.

Okay, but then let's say—what's the cumulative impact of that inflation? So we have the Common Man price index. This uses things like food, energy, shelter, clothing—the things we actually spend money on, which is—a lot of the government data excludes things that you and I have to spend money on—and we find that quite frustrating. So this Common Man CPI includes that.

What you'll notice is, that has continued to march up. Why is that? Inflation is still positive. That 9% inflation compounds on 6% and so forth. When you look at consumer price index—just headline, the dotted line—it is slightly below the Common Man CPI and has been on trend. So when we see a lot of frustration in the marketplace, it's because it's even worse than the headline report.

Then, finally—and I know there's a lot of data points on this chart, so we apologize for that—look at wages. Yes, wages have risen. You hear that a lot. It is true. Wages have risen. They have not kept up with the compounded inflation rate on net. Is there splits between different types of jobs? Yes. But on net, they have not quite kept up. This has really fed into a lot of discussion in an election year and something that we are very focused on.

The truth is, inflation, if it moves negative something went very, very wrong, right? So inflation is already in the price. Now it's about keeping inflation low and wages hopefully keeping up—although you don't want too much wage inflation either because that can have an issue. But this has led to a lot of frustration in the marketplace, even with unemployment rates low, it has been really a critical story in 2023 and 2024.

Brent: 100%. And when you take that further, and we think about the consumption picture on the next slide, Amy, again, we've talked about this as being one of the more important slides in our economic deck. Because why? At the end of the day, more than 68% of US real GDP is consumption.

Phil: Right, yes.

Brent: Another 4% is housing. So the consumer explains about 72% of real GDP. And we've talked about these two lines. Gold line is spending on goods, and the dark blue dotted line is spending on services. We really want to focus on the dark blue line here because services spending is about two-thirds of that spending number, right? So at the end of the day, when you look at the trend in services spending—7% year-over-year growth. Back in the summer, Phil, this was sitting around 6.3% percent around June.

So we've actually seen a stable growth rate in services spending, which is the main driver. It's actually accelerated a little bit from the summer. And I would argue this is an incredibly important thing to see if we're going to keep real GDP growth going. And if I look at something like the Atlanta Fed GDP now, right, we printed 2.8% growth in the third quarter of this year. Expectations as of today are for 3.3% in the fourth quarter. So again, a robust picture for spending and growth.

Phil: It's always interesting this time of year to see how holiday spending turns out. It's a little early to have a great sense for that. And these days, often, with gift cards, et cetera, January is important as well.

Brent: Did you get me a gift card?

Phil: Not yet. It's coming. So one thing I like to think about when we think about services spending, the importance, you know, we love anecdotal data is just what does an airport feel like? We fly a lot for work. And I don't know the last plane I was on that was not completely full. That is an indicator that people are spending. We are still seeing services spending certainly.

Brent: So one of the things that you and I get asked an awful lot on the road is, "Who's doing all the spending? How does it break down?" So this is a newer slide. So let's explain what we're looking at here. We're looking at inflation-adjusted growth in retail spending by household income. So think it economically stratified. Gold line, high-income earners. Light blue dotted line, middle income. Dark blue, low-income households.

And if we just focus on for a moment the dark blue line and low-income households, you can see from the end of 2021 through now, low-income retail spending, inflation adjusted, has been flat, right? We have seen no growth in low-income houses' spending on an inflation-adjusted basis. So the predominant driver of all of this spending has been high-income and middle-income earners. And when we think about the balance sheet and P&L for those high- and middle-income earners, you see house price appreciation. You've seen financial asset appreciation. So we've seen wage growth stratified across all income earners, but certainly in high and middle income. So at the end of the day, the driver of all of this spending has been solidly high- and middle-income earners, which we think could lend itself to the durability of this rally.

Phil: Yeah, when you see before the pandemic, those lines are pretty close, aren't they? So we really are seeing a spreading out exacerbated by the pandemic period. So as we flip ahead, what does this all mean? Well, one, we are seeing some signs of strain underneath the hood that may not be shown in the aggregate data.

So we know consumers are spending. But for those who are living paycheck to paycheck, they're accessing their credit card. And what we see on the left side is credit card delinquencies have risen to levels that we have not seen since after the Great Financial Crisis. Part of what's exacerbating that is the blue line, which is the interest rate on credit cards, right? So not only did credit card usage go up as inflation rose, but rates went up—and that causes strain. Interestingly, that delinquency rate had ticked down recently. That's somewhat optimistic to us, but certainly an area of strain. You see this in auto loan delinquencies as well. It's not just credit cards.

On the right side, these are consumers reporting they're likely to miss a debt payment in the next 3 months. That has risen, of course, to levels we have not seen since the pandemic. Also a little tick down recently, maybe that were to continue. But nonetheless, some of the strain we are hearing out there for some of our clients who are business owners, they're hearing from their employees, is showing up in the data as something we are aware of—even if it doesn't show up in the aggregate data, something we like to highlight.

So let's go back to more aggregate data on the next slide. It's very hard to talk about fundamentals and if they're in place—being market people—and not talking about earnings. In fact, it's the key. So what are we looking at for 2024? We're waiting on fourth quarter, right? We won't get that until January into February. But earnings growth has been exceptional this year—9.6%. The average since 1950, 7.6%. Honestly, as market people, anything in the upper single digits we think is great. Pushing 10% is excellent.

Looking ahead to 2025, 15% earnings growth. Again, remember, this is bottom-up consensus analysts. In other words, analysts who cover companies. Often these numbers get revised down during this time frame and into the first quarter. So far, this number's hung in there.

Brent: It's been pretty sticky for many, many months.

Phil: Which is very interesting. So, you know, when we think about things like our price target, we revise this number down, but maybe fundamentals are stronger than any of us think. We shall see. Even if this were to be revised down materially to like 10%, it's a really good year. What is helping earnings growth is the right side, and it's estimated margins.

This is next-12-month forward margins. We've shown this before. We often talk about this on the road. We all think about this earnings growth as being the key to the market. The truth is, it might actually be margins, right? Investors want to see margin expansion and for those to stay high. We had peak margins after the pandemic when there was huge amounts of fiscal monetary stimulus. Of course, we saw peak. Predictably, that came down. We had inflation. A lot of that stimulus rolled off. What's interesting is we're now near those peaks, levels of margins well above pre-pandemic levels.

So you say to yourself, why has the market rallied so hard? A lot of the story is that the bear case just hasn't played out. And maybe, arguably, the bull case has played out. Does not mean the multiple is not high, does not mean we don't have challenges, but it does point towards pretty strong fundamentals.

Brent: So the next theme that we wanted to cover—and Phil, you and I have been covering this since June, right—which we believe that the Fed may slow the pace of rate cuts even beyond what the market is currently pricing in. It'll be data-dependent, and there's a lot of data to come. But we've been saying for quite a while, especially when market participants pre the first Fed's rate cut in September, were pricing in 10, 11 cuts in this cycle, and we had taken the shorter side of that.

So why don't we jump in, Amy, and let's talk about where we are. Right now today, economists are broken down into two broad camps. One camp that is calling for fewer rate cuts. And again, when we're talking about fewer or more, we're talking about relative to that Fed cutting cycle, which back in September—

Phil: —10 or 11 cuts.

Brent: Yeah, 10 or 11 cuts priced into the market. So one camp calling for fewer cuts, which we're in that camp, and another camp calling for more cuts. So let's systematically go through some of that rationale. And certainly for the fewer-rate-cuts camp, certainly as we've covered already, an incredibly resilient economy. We saw 2022 and 2023 growth revised up, as we just covered earlier. '24 sitting at 2.7%. Expectations for 2025 now sitting at 2.1%, up from 1.7%. So a very, very resilient US economy and economic growth picture. We talked about the labor market and how durable that's been.

Financial conditions, financial markets and S&P 500, like we talked about, up more than 63% cumulative over the last 2 years—29% this year. Financial conditions are easy across the board. Corporate credit spreads are very tight. Sort of that spread relative to treasuries. Still very, very tight. And inflation, while we certainly showed in your slide, moderating lower, yes, but still high and significantly above the Fed's target of 2%. And certainly, data will come, and we'll have to look at it. But by and large, we see a very strong economy that doesn't need more stimulus.

Phil: Yeah, so what's the rationale for more rate cuts? Well, first, the fed funds rate still looks elevated versus 2.5% inflation, right? There's still some room for cuts. And by the way, we aren't saying no more cuts. We're just saying not dramatically more. We'll talk about that more in a moment. The unemployment rate has risen. I mentioned that it's kind of flatlined at 4 to 4.3%, but we're above the bottom. Delinquency rates, as we covered, are on the rise as well. Growth is potentially moderating, arguably.

So what is the state of play for the federal funds rate as we flip ahead? So where were we before the September 18th meeting? We had that range of 5.25, 5.5% fed funds rate. We'll call it 5.4%. We'll just take the median here, guys. Where are we today? Well, the Fed cut 50 basis points in September and another 25 basis points, or quarter point, in November. So that's the equivalent of three quarter-point cuts. We're calling a cut here, quarter of a point, 25 basis points.

So now we're at this 4.6% range. Looking to the end of next year, which is we had mentioned at one point there were 10 or 11 total cuts priced, now it's roughly 6.5. And this changes every day. This is through the 10th of December. So what does that mean? Likely a cut in December, and then two, maybe three cuts all of next year. The Fed at the December meeting, which is next Wednesday, is—first of all, they're releasing a summary of economic projections—and there's a reasonable chance that they indicate a pause of some sort, whether that's a quarterly beat, et cetera.

So we think that the every-meeting cut cycle probably is coming to an end in December, and they're going to be much more data-dependent. Doesn't mean they aren't cutting, but the idea that they're just going to cut rapidly, meeting after meeting, given how resilient the economy has been and inflation has been as well, we find to be pretty unlikely.

Brent: Agreed.

Phil: So flipping ahead, we mentioned, we expect—this is really uplifting—we expect lower future returns from here, but this is in the context of what is very good news. So as we flip ahead, what has been just—this is just a risk asset. We understand our clients are in diversified portfolios. When you look at the S&P 500 rolling 10-year returns—so you're looking at an annualized rate—but what have returns been rolling over 10 years? What have they been most recently? 13.3%.

So annualized each year over the last years, they've averaged 13.3%. Now, that is not that they're up 13.3% every year. It is that that is what the trend has been. The long-term average is 10.6%. So well above long-term average. Much like the multiple and other metrics we watch, rarely are you actually at the average, and you can cyclically be above or below it for quite extended periods of time. So it does not mean that tomorrow we mean revert to the average. And if you're below, same thing. It can take time. But it does show that we're at a range, what, 30% above the long-term average for a 10-year period. So we've really had exceptional returns.

Brent: Yeah, and it's really important because when we think about financial planning and using sort of, hey, the US equity market has returned 10.6% for almost 100 years now. Again, understanding that that average sees a lot of high highs and low lows that geometrically compound to the average. So living and dealing with market volatility is the only way that one can invest in equities because you can see this isn't a straight line up. It has been very variable for the entire history of the S&P 500.

Phil: Yeah, volatility is the norm in equity. And if one wants to invest in equities, you have to be able to take those periods in which they're down for an extended period and periods in which they're up for an extended period.

But all of this strong rally in equities, as we flip ahead, has resulted in a fairly expensive market. So here we're showing price-to-forward, 12-month earnings. All that means is, what are you willing to pay for a dollar of next 12-month earnings? So above, right, of course, is more expensive. Lower is cheaper. Much like price, rarely are you actually at the average. So when you hear a pundit say, "Well, the market's expensive or cheap versus average," and they're indicating that tomorrow it's going to mean revert—that's not great advice. In fact, it could take a long time. But it is quite expensive, not quite at the peaks we were post-pandemic and certainly not the peaks we saw during the tech bubble. But there's no world in which we can say this market is cheap and certainly in the next 12-month earnings.

Brent: And another way that you and I like to look at this here on the next slide is a similar valuation metric, a little bit different. It's called the Shiller CAPE ratio, which sounds very fancy and complicated. It's actually pretty straightforward. It's nothing more than the price of the S&P 500 divided by 10-year, trailing-average inflation-adjusted earnings, right. So a more normalization of a business cycle.

And what you can see here is that similar to that next-12-months forward P/E ratio, the Shiller CAPE ratio is elevated at more than 37 times. And we've only seen three other peaks in history kind of at these levels. But I think what's important, sort of what you highlighted, Phil, is that the Shiller CAPE ratio does a very bad job of short-term performance indication. So look at what we're calling out here, where we hit 38.3 times in December of 2023. If you use that as a short-term valuation metric, you would have sold out of stocks at the end of 2023 and missed this 29% up-rally that we've had this year. So not a very good job at short-term predictions.

But when we flip onto the next slide, Amy, and we think about its ability to be an accurate predictor of longer-term performance—and what we're looking at here is decade-long performance. So to interpret this graph, on the vertical axis we're looking at 10-year annualized real returns for the S&P 500. They're the dots. And on the horizontal axis, sort of left to right, is that CAPE ratio. So the higher the CAPE ratio, the lower the next 10 years’ real average returns.

And what you can see here, calling out some examples, where once you kind of get over 30 times, the next decade has had a lower real return in some situations. That decade when you had a really high Shiller CAPE ratio, the next decade actually produced a negative real return. So think about the decade that ended in 2001 or 1999 or 2000. You can see they certainly cluster, but you've had those periods.

So what many market participants or some of our clients or prospects listening to this is saying, "Well, Phil, Brent, are you telling us to get out of stocks?" And as you can see on the next slide, the answer is absolutely not. The answer is to diversify. So here's an example of one of those dots that we just look at, and it's one of those decades that was aptly named The Lost Decade. So think about from the beginning of 2000 all the way through the end of 2009.

The S&P 500 annualized for that entire decade at negative 1%, right? But as you run your eye down the list, look at mid-cap stocks, look at small-cap stocks—both core, value. Look at developed international stocks. In this specific, we're looking at all international stocks, both developed and emerging. Look at core bonds. All did anywhere between 4 to 9% per annum better than the S&P 500. So the answer is—in a period of high valuations, it's not in or out, which is a bad thing to do. And we'll talk about market timing later. It's making sure that you broadly diversify your equity exposure beyond just US large-cap stocks.

Phil: And what's interesting about The Lost Decade is—remember, it started with the bursting of the internet bubble, right, that went 2000 to 2002 period. You had a little bit of a recovery, then you had the Great Financial Crisis. So you had these two really exceptionally rough periods for investors and for the economy and for Americans. And you had positive returns in most asset classes. That is pretty fascinating to think about.

So as we flip ahead, you know, again, we and everyone talks a lot about the market being really expensive, and within the US, especially large caps. What's interesting, though, is it's really focused on the largest names, right? If you look at that price-to-forward earnings that we showed previously, but you break it out between the top 10 and numbers 11 to 500, you'll notice that, yes, the top 10 are expensive versus their own history—11 to 500 are basically where they've been the last decade, right?

And there are reasons that the top 10 are so expensive. These are really big companies with a lot of pricing power. In certain cases, they dominate their marketplace. So there's a reason that they're expensive. So when we talk about broadening, which we talk about all year, and we start to see more of that in the back half of the year, and we think that could continue—this is why. It's hard to paint the market with one brush. There is opportunity outside of the top 10. To that point, what is our price target, as we flip ahead?

So our price target: Base case is 6,400. That's up roughly 6% from the closing price on December 9th. That is, I describe, as a cautiously optimistic type price target. And we get there—it’s going to shock all of you—we do not just pull this number out of thin air. We actually look at earnings expectations. And for the base case, for example, we revise the next 12-month earnings expectations down, right, that 15%. And then we have earnings expectations growth slightly above average the 12 months after that—so months 13 to 24. And then a fairly flat multiple, in other words, price to earnings.

So we are not max bullish in terms of our base case, but we do have an up year. And if you think about how great this year was and 2023 was after the selldown in 2022, a 6% type year, I think, would be fairly welcome. The bear case, of course, is much more multiple contraction and earnings disappointment, and the bull case is earnings really come through as expected, which would be really incredible.

Brent: Love to see.

Phil: And more earnings growth and a little bit of multiple expansion. Even in our bull case, we do not have a lot of multiple expansion. Because in our view—and when we say multiple think about price-to-forward earnings, for example—we think the market's quite expensive. So we are not putting a lot of multiple expansion even into our bull case.

Brent: Yeah, so I think this next theme, in my humble opinion, I think is probably one of the most important for investors that are listening. And that's portfolio diversification has always mattered. But we believe that portfolio balance and diversification is going to matter more in the coming decade than maybe at any other point in time.

So let's kind of get under the hood and talk about this. So on this first slide, we're breaking it down into two simple asset classes. The first in orange is US large-cap stocks as represented by the S&P 500. And in the blue, we're looking at US core taxable bonds represented by the Bloomberg Barclays US Aggregate Bond Index.

And I want everyone to look at this first column. For the 10 years ended in November, US large-cap stocks annualized, and you covered this already, 13.3% per annum—an incredibly robust number. Bonds, on the other hand, think about what you talked about just moments ago with the drawdown that we saw in 2022, which was the largest drawdown in the history of the almost 50 years of the agg bond, annualized at only 1.5% for an entire decade. So the spread between US stocks and bonds of almost 12% was in the first quartile of highest spread differentials post-World War Two.

So think about that for a second. Every dollar that you had put in bonds relative to stocks over the last decade cost you about 12% per annum, which geometrically compound is a big number. It's a big spread. So let's think about what the next 10 years might bring. And when we look at the next 10 years, we are looking at what's called the Horizon Actuarial study, which is a firm that aggregates 41 of the largest firms out there that does forward-looking capital market assumptions like we do, and pulls that all together.

So what we're looking at here for large-cap stocks and bonds is the average of those 41 folks. And you can see the broad market participants believe that over the next 10 years that US stocks will annualize at about 6.5%, which is below the average that you highlighted over the last hundred years at about 10.6%, but still a decent number. What's the most starkly different is the expectation for fixed income. The average of these 41 participants believe that bonds will annualize at 4.9% per annum for the next decade. So that spread differential between stocks and bonds at 1.6% is in the lowest quartile of spreads between stocks and bonds post-World War Two. So two periods that are diametrically opposed.

So if I pull this forward into what that means from a portfolio perspective on the next page—because rarely do our clients own just stocks or just bonds, they own a diversified portfolio—let's look at two portfolios here, an 80/20 portfolio, so 80% stocks, 20% bonds, and then a portfolio that's evenly divided between stocks and bonds. And again, let's take those numbers and look at the decade that's ended. Eleven percent for an 80/20 portfolio and 7.4% return for a 50/50 portfolio. And again, hypothetical portfolios of just two individual securities. That spread of almost 4% was pretty robust. So where you were on the efficient frontier over the last decade mattered a lot for annualized returns.

Over the next decade, 6.2% for an 80/20 portfolio, 5.7% for a 50/50 portfolio and again, a spread differential of only half a percent. So if we think about the volatility implications of an 80/20 portfolio versus 50/50 and what that ride may look like over the next decade—starkly different. Again, for a spread differential, that's pretty modest. Again, these are hypothetical portfolios. And this is, again, extrapolating the consensus of these.

Phil: These are not our forward-looking returns.

Brent: Ours are a little bit higher. But again, taking the average of what most market participants are thinking, starkly different decades—the one that just ended and the one that we might be heading into.

Phil: It just highlights the importance of balance. That's really—the level may not matter as much as the spread.

Brent: That's right.

Phil: The level we don't really know. No one knows perfectly, but there is a lot of reason to think that the spread between fixed income and equities is a lot tighter. To that point on fixed income, as we flip ahead, what is the yield-to-worst of a number of fixed-income indices? Look at aggregate bond at 4.6%. Look at high yield at 7.1%. You are getting yield in fixed income, something that we couldn't say that long ago. The 10-year at 4.2%, this was yielding roughly 0.5% the summer of 2020. And that was not that long ago. It feels like yesterday, just shows multiples higher from a yield perspective. So there is opportunity.

So what does yield mean for return? So as we flip ahead, here we're showing the aggregate bond index return is percent capture of yield-to-worst. So in other words, pick a hypothetical month Y. You have aggregate bond yielding, let's say 6%, and a duration of 5 years. The question is, over those 5 years, how much of that 6% do you capture? So we have 100% line here. If you average from 1995 forward, the average is 108% capture. In other words, you generally capture not just yield-to-worst, but even a little bit more.

The exception, you will notice, is recent years. Why is that? You had historically bad period, two periods, 2 years in a row of a negative return on the agg—never seen that before—and the worst year in its record. That pulled down those returns. But we are in a different regime now. We now have yield north of 4%. We aren't coming from unbelievably low levels of yield. So there are reasons to think that yield-to-worst is a pretty decent indicator of forward return.

Brent: Yeah, agreed. So let's get to our last theme, these market tenets to remember. I personally think, and I have this, I think everybody listening to this call should take these five slides, take them out of this presentation deck and hang them up in their office at their home. And anytime we get into bouts of market volatility, remind yourselves of these key tenets that will keep you tied to the mast and in line with your investment policy.

Phil: We do this all day, every day, and we have to remind ourselves of these tenets.

Brent: Yes, exactly. So let's hit the first one, which is something that you and I say all the time. I literally think every presentation we do, we remind people that market timing is a very, very dangerous game. So what are we looking at here? Because there's a lot of numbers here. We are looking at a hypothetical $10,000 invested in the S&P 500 from January 1st of 1995 all the way through November of this year. So almost 30-year time period. On average, there's 240 trading days in a given year. So you're talking about 7,200 trading days. So if you look at that first bar, you put $10,000 into the S&P 500 January 1st of 1995. And guess what you did, Phil? You did nothing. You went to work. You went fishing.

Phil: You enjoyed your life.

Brent: You enjoyed your life. That $10,000 compounded to over $131,000 over this 30-year period, right? So what's interesting as you look at the bars to the right, if you missed 5 of the best days, so think 5 days out of 7,200 trading days, you had almost 40% less. So instead of compounding to $131,347, you compounded to only $83,000. Still a great number, but you gave up almost 40%. God forbid, you missed 20 of the best days out of the 7,200. You had almost three-quarters less money.

So you might be asking yourself, what is the probability that I might actually miss these best days? Well, here's the crazy thing is that best days in market cycles cluster together. And if you look at that callout box on the right, nearly half, about 48%, of the S&P 500's best days occurred during a bear market. Another 28%, Phil, occurred during the first 2 months of a bull market when nobody knew it was a bull market. So a full 76% of the S&P 500's best days occurred when you never want to be an investor. So what are the chances that you missed the best days if you're worried about what's going on in markets? Very, very high. So stick with the plan and remain invested.

Interestingly, this is another chart that I think this is my personal favorite. We talked about we're 2 years into a bull market for stocks. We're up 63% in the S&P 500. What shakes investors out of their investment game plan are market drawdowns, Phil. So what we're looking at here is every 10% or greater drawdown post-World War Two. And you can see there is a number of them. I want you to focus your eyes at the very bottom and look at the median and averages.

On median and average, the amount of time that you're actually down in months as it relates to a drawdown is between 7 and 8 months median average. So usually market declines don't really last that long. How often do they, or so how significant do they fall? Between 19 and 23% median average. But I think what is incredibly important is if you think about the returns 1 year post the low or that second-to-last column, which is how much do you recover of the previous high 1 year after the bottom, you can see median and average—105% and 106%. So when you look at months from peak to full recovery, median observation going back to 1950 is from peak to peak. You're getting all your money back in about 12 months.

Look at that 1-year recovery post the bottom: 71 to 77% in the first year. So if you're out of the market, when you see market volatility, that could significantly impair your ability to recover. So again, pull out this slide, remind yourself if we get into a little bit of volatility that it doesn't last that long, and it recovers pretty quickly.

Phil: That's right. So if if we haven't hit enough angles, let's do one more. And this is analysis that we just updated recently that I use every presentation I give. And it certainly seems to resonate. So what is the percent capture of investing $12,000 annually, 1980 to 2024? So 44 years, you have $12,000 dollars. Each year, you invest that $12,000, right? Every year you invest, but you invest in four different ways. And what does that look like? So let's say the first way you're omnipotent. Somehow, every year you buy at the yearly low. One year that's March. The next year it's September. But somehow, every year you time it—this is an impossibility. Let's just say somehow you do it. If you invest $12,000 a year for those 40-plus years, that generates $17 million of return.

Brent: That's incredible.

Phil: You capture 100%, right? Okay, let's say in the second bar, right, the second set of bars—

Brent: Which a lot of clients think that they are the worst timers.

Phil: Sometimes it feels that way for me. You're the the worst timer in the world. Again, this is an impossibility, but somehow every single year you invest in the yearly high. One month, that's in February. Maybe the next year it's in November. But every year at the yearly high, you invest. Worst timing, right? You still capture 76% of that $17 million.

Okay, now two more real-world scenarios. You invest in the first day of the year. There are people that do this. In fact, I meet them on the road that say, "You know what? I accumulate, and then the first day of the year I invest." So you invest on January 1st. You capture 92% of that $17 million. Why is that? Markets go up more than they go down, right?

Okay, let's talk another very real world, what many of us do through 401(k)s, et cetera, is monthly dollar-cost average, $12,000 a year, but it's $1,000 a month for 12 months. You capture 87% of $17 million, right? Pushing 90%. So let's say you just cannot pull the trigger. For 44 years, you just sit on the sidelines, and you invest in cash. You capture 3% of that $17 million.

So it is time in markets, it's being invested. Even if you are a bad market timer, just invest, hold your nose and put it to work for long-term assets. You have to have a plan. You have to have short-term assets. You have to have that balance in your portfolio. But for long-term assets that you do not need in the near term, in the coming few years, let's say, invest for the long term. That is really a great strategy.

Another thing we hear a lot is, and we've shown this, just to put a point on it, we've shown this for multiple years because for multiple years we have heard, look, there's so much geopolitical concern. Whether you're looking at the Middle East, Eastern Europe, concerns in Asia, concerns, you know, we had an election year this year that a lot of people were worried about.

The truth is, there is always a wall of worry, right? If you invested $10,000 in 1970, that is worth $3 million today, right? Think about what—we had a Cold War. We had an end of a Cold War. We had 9/11. We had wars, really awful events. The market can sell down. But generally, if you look around geopolitical events, the bottom for the market is after 16 days. And usually you have taken 16 days to recover. That's 3 weeks. Sixteen trading days is 3 weeks. So very quick recovery on average from geopolitical events. That does not mean these concerns are not real. They are real. It's that the market tends to look through them.

This year, by the way, the geopolitical events we are mentioning were already in place coming into this year, and look at what the market did. So it's not that we enjoy geopolitical events. It's just that the market is quite resilient, and so are US corporations and international corporations.

Brent: And I think the big takeaway when I look at all this is—let us help you. This is the reason why you have a financial plan to take all your goals and objectives and figure out what they need to be and what is that rate of return that ties into seeing all your goals and dreams through to fruition, whether you're an individual or you're an institution, making sure that you have a cogent financial plan allows you to better navigate the constant geopolitical risk, the markets ups and downs.

Having a plan allows you to know why you're invested. So allow us to help you, allow us to develop that financial plan. So if you're taking one thing away and you haven't done that, one of your New Year's resolutions, if you didn't do a financial plan, you should be speaking with us about that financial plan to keep you on the straight and narrow.

Amy: Well, Brent, Phil, thank you both so much. That last slide especially just really tells the story of how the market defies gravity over time.

Just a reminder to everyone, thank you for being interested in this information. If you'd like to have more, there are several publications available throughout the month. You can sign up for our Making Sense subscription, and we will send you information throughout the month. If you're not already subscribed, you can hit the QR code or visit FirstCitizens.com/Market-Outlook to get signed up.

As always, Brent, Phil, thank you so much for the guidance and leadership throughout this past year. And I'd be remiss if I didn't mention Blake Taylor's contribution to the Making Sense team throughout this year. And as always, I want to thank our listeners for trusting us to bring you this information throughout the year. Your trust in us is something that we never take for granted. On behalf of all of us here at First Citizens Bank, we hope you and those closest to you have a safe and happy holiday season, and we will see you back here in 2025.

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Authors

Brent Ciliano CFA | SVP, Chief Investment Officer

Capital Management Group | First Citizens Bank

8510 Colonnade Center Drive | Raleigh, NC 27615

Brent.Ciliano@FirstCitizens.com | 919-716-2650

Phillip Neuhart | SVP, Director of Market & Economic Research

Capital Management Group | First Citizens Bank

8510 Colonnade Center Drive | Raleigh, NC 27615

Phillip.Neuhart@FirstCitizens.com | 919-716-2403

Blake Taylor | VP, Market & Economic Research Analyst

Capital Management Group | First Citizens Bank

8510 Colonnade Center Drive | Raleigh, NC 27615

Blake.Taylor@FirstCitizens.com | 919-716-7964

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