Making Sense: November Market Update

Amy: Hello, everyone and welcome to the First Citizens Wealth Management webinar series, Making Sense, where Chief Investment Officer, Brent Ciliano, and Director of Market and Economic Research, Phil Neuhart, help you make sense of what's going on in both the markets and the economy. I'm Amy Thomas, a strategist here at First Citizens Bank, and before we get started today we do have a couple of housekeeping items to get through.

First, this webinar is being recorded, and a replay will automatically be sent to you following today's conference. Secondly, this webinar is interactive. If you'd like to ask a question, please use the Q&A or the chat feature on the right-hand side of your screen. All questions are confidential and only visible to myself and the panelists. I do want to remind you, we do try to keep the discussion broad. So if you have a specific question about your financial plan or we're not able to get to your question on today's discussion, please reach out to your First Citizens partner. As a reminder, the information you're about to hear are the views and opinions of First Citizens Bank and should be considered for educational purposes only. Brent, with that, we're ready to go. I'll turn it over to you.

Brent: Great, Amy. Well, thanks so much and good afternoon, everybody. I hope you're well. Phil, I cannot believe that next week is Thanksgiving already. I literally just put away all of my Halloween decorations.

Phil: It's unbelievable.

Brent: So from Phil and I to all of you, we hope that you get to spend some time with loved ones and certainly travel safe. I am disappointed, Phil, that you didn't wear your turkey outfit today, but we'll talk about that in the Q&A section.

Phil: Next time, maybe. We'll see.

Brent: So, why don't we jump in, Phil? What are we going to cover this afternoon?

Phil: So first, the economic update. As always, there's a lot going on in the economy. No surprise to anyone on the call. We'll dig in there on inflation, the labor market, etc., and then on the market, want to dig into some things that are changing. What are we seeing in markets, areas of support, areas of resistance? Really understand what's going on in markets and our views there. So, Brent, you want to jump right into the economy?

Brent: Yeah, let's talk about the economy and we'll get started there. So the first thing we want to talk about is an area of underlying resiliency, Phil, that we've seen for quite a while, and that's the US labor market where we continue to see robust job creation. I mean, 261,000 jobs were created in October exceeding expectations, 347,000 jobs on a six-month moving average, almost 350,000 jobs, just incredibly strong. And we had claims today that came in strong, continuing claims that just continue to support the underlying resiliency of this labor market. And while the unemployment rate did tick up from 3.5% to 3.7%, that was coming off the lowest level for unemployment in more than 50 years.

Phil: Still a tight job market, certainly.

Brent: Absolutely and you know, if we go to the next slide, Amy, you really can't talk about the labor market unless you really check in on the pulse of the US consumer, Phil. And the US consumer's not really feeling so great right now. And it's for many of the reasons that you and I have said multiple times, which is, high inflation, global supply chain issues, shortages, discord with Washington, D.C., were all cited in the University of Michigan survey that we're seeing that depressed consumer sentiment. We hit an all-time low back in June, which was the lowest level ever recorded, going back all the way to the 70s. And while we've seen that tick up, when we saw gas prices moderate a little bit, it's been a very, very volatile data series. The good news is that this decrease in consumer sentiment has not yet fed back to a decrease in consumer spending, which is a really good thing because more than 2/3 of US Real GDP is consumption. So as goes the consumer, so goes our economy. What we're looking at here is, the gold line is good spending, and the gray line is services spending. And while they're both moderating lower in nominal terms, they're both significantly above that long term average, Phil.

Phil: And just this morning or yesterday, rather, we received the most recent retail sales report, and it surprised to the upside. Even if you exclude auto and gas spending, which can be very volatile and driven by price, it was surprisingly strong. Now, in the details, there's some evidence that consumers are switching away from discretionary items, changing preferences, as inflation takes its toll. But still, the consumer has been outperforming expectations.

So that's the good news. Let's turn to inflation, which has really been the issue.

Brent: The persistent bad news.

Phil: Yeah, the persistent bad news all year. So here we're showing consumer price index. You all have seen this chart before and the gray bars is realized, actual inflation and then the gold bars are the consensus estimates. So few things. First of all, we're running up four-decade high inflation. Secondly, consensus does expect it to moderate, but at a very slow pace. So first quarter of 2023, 6% inflation. That's three times the Fed target of 2%. We have seen in the last week, we did see this, headline inflation has moderated a touch. Now, below 8%.

Brent: Yeah.

Phil: Nothing to write home about, but the directional vector is important. Look at what the market did last week on that report. It remains a very macro market. What is moving markets are things like inflation and the Fed. Now, the caveat here is that these are consensus estimates from economists. They have gotten it wrong this cycle.

Brent: Yes.

Phil: So you look at the black diamonds, those, that's where consensus was in March, which is not that long ago. Look at how much lower those black diamonds are than where inflation has come and where is expected to be now.

Brent: Yeah.

Phil: So all this inflation on the next slide has forced the Fed's hand. So the Fed, Federal funds rate we're showing here, this is the overnight rate, has gone from near the zero bound, the range of 0 to 0.25% to an upper bound of 4%. And in that gray line, you see that's really the vertical move upward.

Brent: It's a rocket ship up.

Phil: It's a rocket ship up. That is different than the last couple of cycles and the last cycle we're showing here, this nice little stair step up. The Fed would hike each meeting, take time off, hike a little bit more quarter point. Now we are getting massive hikes and that is moving us up very quickly. And what the Fed's communicating in their own estimates, which were showing the gold line here, is they're going to remain aggressive. So these are their estimates from September. We get new estimates in December, which will be important. They are saying not only are rates going to be higher into this year, but higher next year. So the idea over the summer of this Fed pivot—

Brent: Yeah.

Phil: Well, maybe the pivot is, they stop hiking at some point. I think they're going to start cutting very soon. They're saying we aren't doing it.

Brent: Yeah, we've seen numerous voting Fed officials talk this week reinforcing that hawkish stance that they will be higher for longer. And the market keeps fighting against that. And there's going to be this reckoning between the two and we'll get to that in the market section.

Phil: Yeah, that's right. And if you turn to the next slide, one thing that is often talked about is what's the prerequisite for Fed easing or just the Fed to stop hiking? And one thing is real interest rates. So here in the gold bars, you have Fed funds rate at various periods at the end of prior tightening cycle. So look at the various years here, 2018, most recent 2006 before that, the Fed funds rate is above CPI. Right? So in other words, the Fed is going to hike to a level that exceeds the consumer price index. In other words, interest rates above inflation. Right now, the inverse is true. As you can see here, 4% Fed funds CPI at 7.7%. So what needs to happen is that gold bar needs to go higher. The Fed needs to continue to hike, which they're going to, and they're telling us that. CPI needs to go lower, which consensus believes is going to happen, but we need to see it. And what, the, why the Fed remain so hawkish is they are trying to build this into expectations.

Brent: Yeah, yeah. And it's not one moving and the other two points we're really highlight, they're both moving. Right, and I think as you run your eye, you know, to the left on this graph. And you see what's going on, we've seen periods of time where that Fed funds rate has been higher. Right, and I don't want to go back beyond the last 20 or 22 years. We're certainly not saying that we expect Fed funds to hit 9.8 or 11.8 or, God forbid, 20. But something certainly north of 4% is warranted relative to where we see position of inflation.

Phil: That's right and that's why I think the Fed is really being persistent in the press and in conferences trying to get this expectation out.

Brent: Absolutely.

Phil: So let's talk on the next slide in terms of causes of inflation. And then in the next few slides, we'll talk about reasons why inflation could come lower. So first into money growth, this is money supply growth, right. And on the left side, this is long term since back to 1961, you can see the unbelievable growth in money supply during the pandemic and the period after. This is fiscal stimulus, huge fiscal surplus, record fiscal stimulus, huge monetary policy from the Federal Reserve. You can see it's more than double past periods of money supply growth. So with this and the benefit of hindsight, it makes some sense when we have some inflation, and it wasn't as transitory as the Fed believes. Now, the good news is that money supply growth has come in and it's good news, arguably maybe not for markets, but from an inflationary perspective. Why is that? Fiscal tightening, monetary policy tightening. Now that can be a good sign for inflation. On the right side, we are showing that same money supply and that decline in growth along with core CPI. All core consumer price index is, is CPI or inflation excluding the impact of food and energy. So core prices, that tends to track money supply growth on a 13-month lag. So 13 months is a long time, but—

Brent: It is.

Phil: We have recently seen a tick down, we don't have here, from last week and core CPI. Does that trend continue? We hope so. And money supply coming down is really a prerequisite for that to happen.

Brent: Absolutely and on the next slide, another key data point that might be indicating that inflation, moderates over the coming weeks and months is something that everybody on this call watches pretty much every day Phil, which is the price at the pump. And you can see we bottomed out in April of 2020 at about $1.87 a gallon. And again, this is US retail gasoline prices on a national basis. Our friends in California wouldn't agree with that. But when we see that incredible spike in a rise of almost three times to a high of $5.10 in mid-June of this year, but since then, we've seen gasoline prices moderate lower. They've fallen almost 25%. And it's not just gasoline prices, Phil, we've seen much of the energy complex, moderate lower, things like natural gas, home heating oil, WTI, crude coal have all fallen back. So hopefully from at least a headline perspective, we can see a little bit of moderation in the energy complex.

Phil: Right, and the direction is important for markets, right? Unfortunately for consumers, we are still well above the average years.

Brent: For sure.

Phil: So, so when we think about things like consumer spending, it still is a hindrance.

Brent: Yeah, another pressure that is moderating is the global supply chains, broadly. Right, and what we're looking at here is the New York Federal Reserve's global supply chain pressure index, which looks at delivery times, delivery costs, freight rates, new order backlogs, etc., et cetera. And we've seen significant moderation down in those pressures. But looking at this chart, going all the way back, we are still well above the long-term levels and it's going to take some time for these to moderate further. And that's holding geopolitical tensions constant. If, God forbid, we saw an escalation in the war in Ukraine or tensions in Asia, you could certainly see these pressures rise in that movement further. But for now, we're in a good place.

So this is probably the big one that everybody is focused on is the US housing market and the US housing market is unequivocally slowing as the confluence of slower economic growth, high mortgage rates and high home prices are creating that negative feedback loop into the housing market. And when you look at the left-hand side graph and you're looking at existing home sales, if I looked at existing home sales or new home sales, you'd see basically the same graph and that's falling significantly. On the right-hand side, you can see US home builder sentiment is fundamentally crumbling. We had a data point this week it fell even further.

Phil: Correct.

Brent: Right, so, so that's been an issue on the next slide, Amy, when we look at the year-over-year change in home prices and the graph on the left, when we look at the Case-Shiller national home price index, since it's peaking in April, it's fallen every single month since then. And then when you look basically on that right-hand chart and look at the months' supply of existing homes Phil, it is ticking up ratably.

Phil: Yeah, and a question we often get is, look, home, housing market is slowing—

Brent: Yeah.

Phil: When that happens, there's always pain, right? We don't like attaching the phrase soft landing to the housing market ever. There will be pain, but is this a great financial crisis type pain? Like '08, '09, we think that probably not. One reason is that months' supply chart. It's ticked up and that's why sales are falling, months' supply is going up. You, look how tight inventory was coming into this housing market slowdown compared to pre-2008.

Brent: It's like all-time lows.

Phil: Yeah, so you're very tight coming in. That's a good thing. Again, there will be pain. Another good reason is on the next slide, which is credit quality. So we're showing FICO score here. We're going to focus, we're showing mortgage and auto. We're going to focus on mortgage median for now. You can see where was the average FICO score, the median FICO score coming into 2020 versus where we were, say '06, '07. Right, and one, it's much better, right? Not too surprising, right, living standards were certainly tighter and credit quality was better. One thing you will hear, though, is, well, right, but there was a lot of fiscal stimulus, which improved people's FICO scores.

Brent: That's right. Balance sheets were better, home prices were higher, et cetera. That all Fed into that.

Phil: And that's true when you see that up leg from 2020 on. But look before the gray bar of the 2020 recession, the average was still way above where it was in the past cycle. So there's still is real credence to the fact that credit quality was better again. So there will be pain. We would not want to ignore that, but we do think credit quality was better this cycle. Turning to the next slide, looking at commercial property, this shows the commercial property price index. When we met last month when we did this webinar, this was around zero—

Brent: Right.

Phil: Year-on-year price appreciation

Brent: The month before was positive 10.

Phil: That's right. And now we're negative. Now a couple of things. First, commercial property is lumpier, right? It's not as many transactions. It actually went negative in 2020, which we did not see elsewhere. So in moving down, it does do this a little bit more often, but it is showing that, look, higher interest rates don't just impact the residential market, of course, they impact the commercial market. Commercial property, the one caveat I would give is if you think residential is regional, commercial's very regional.

Brent: For sure.

Phil: Because one big construction project in a town of a certain size can be a big deal. So very regional. But.

Brent: This is National data as opposed to anything regional.

Phil: That's right but nationally, we are seeing slow down. So what does all this mean for inflation expectations? This is really important data for the Fed. This is, in fact, a Fed survey. They survey consumers. These are not economists. They are surveying consumers. What are your one- and three-year ahead inflation expectations? And what they're finding is that first, unfortunately, in the last year and a half, the one-year number went up in a straight line.

Brent: Yeah.

Phil: And that really concerns the Fed because realized inflation, that happened. You can't control what's in the past. But unfortunately, if inflation expectations get into consumer expectations—

Brent: Yeah, if they become deeply entrenched, you really have a problem. It's hard to unwind.

Phil: Yeah, potential for wage price spiral. That's really problematic. The good news is, is that has come down, it's come down pretty materially. Now, way above expectations. But like with much of this data, the directional vector matters. Them coming down is good news. And I think when you look at some of the positivity in markets of late, some of it is this is that, well, maybe inflation expectations aren't moving up in a straight line forever. This is a positive—

Brent: In some of the recent prints helped bring that through as well.

Phil: That's right. That's right. So another question we often get is, what is the risk of entering a recession? We are at 60% chance of a recession in the next 12 months. We've been there for some time now for months. Two main reasons why. One, inflation is not moderating at a faster pace. Right, and the Fed's reaction to that inflation and their increased hawkishness. So if you rewind nine months ago, inflation's outperformed compared to those black diamonds we showed in the bar chart for inflation. And the Fed's hawkishness has increased. So we do think odds on recession next 12 months, but it's not a slam dunk.

Brent: Nope.

Phil: But there is certainly a possibility that the Fed walks a tightrope, and we make it through. But we do think there is a recession risk.

Brent: Yeah and we get often asked what are some of the signs that we might be actually getting there? And the thing that we've talked about over and over and over, it's the labor market, the labor market, the labor market. As long as consumers are gainfully employed and they're having a paycheck, it supports spending. It supports their ability to get through. And the potential for a softer landing. That's certainly something that we're going to have to really monitor as the Fed continues to tighten financial conditions, which could get to a point where it might impact the labor market as we go forward.

Phil: That's right. There's some early indications of labor market slowdown. We often get questions, a common question in all economic environments is, what is something I can watch regularly on the economics? I might answer always, no matter the environment is initial jobless claims. It comes out each Thursday at 8:30 in the morning. It's weekly, so you don't have to wait for super-lag data. It's pretty current. This morning it showed low initial claims, but generally when there's going to be labor market weakness, you start to see those claims tick up. So something to keep an eye on.

Brent: That's great. So let's transition from the economy and let's talk about markets and let's jump in. We're going to first start with fixed income markets. Phil, you and I have been talking about this all year. We are seeing this year, the largest drawdown in treasuries in more than 100 years, the largest drawdown in the US Aggregate Bond index in the entire data series going back to 1976, same thing for municipal bonds, etc., et cetera. But I think all of our clients should focus on is the column on the right, which looks at where current yields are today. Over the last month or so, we have seen a rebound in a lot of the fixed income markets, knock on wood, that that continues. But what's most important to me is that the forward expected return for these asset classes is broadly a manifestation of current spot yields. And run your eyes down that list. We are looking at some very attractive yields right now, almost 5% for the AG bond index, municipals almost 4%, and that's nominal. On a tax adjusted basis, you're in excess of 6% before the rally over the last couple of weeks in corporate high yield, you had yields in excess of 9%. So again, while it's been tough this year, we're starting to see a little bit of a rebound and forward expected returns look better because of a spot yields.

So I think the question, Phil, on the next slide that you and I get a lot over the last handful of weeks is we've been in a trading range for the S&P 500 for the last couple of months, let's say between 3,600 and 4,000. Where, first of all, are the areas of support and resistance? And which way do we break, and do we stay that broken or that way? Right, no pun intended. So let's talk about where those areas of resistance are. 3,900 has been that area of resistance. We've recently broken above that a little bit of choppiness the last couple of days. And then that area of support recently has been about 3,700.

So let's talk about which way we break and let's talk about a slide on the next one, Amy, that we've talked about a number of times where let's look at valuation implied levels of support. And what we're looking at here is the next 12 months forward PE ratio, which is nothing more than what investors are willing to pay for a dollar of the next 12 months earnings. So if I go back and look at the last decade plus the average PE multiple that's provided that valuation support is roughly about 15 times when I average that all together, the lowest we ever saw was 14 times. And when we look at where the next 12 months earnings per share is, that's fallen. When we talked about this on many Webex's, that's come down from as high as 240 something to 230 something, and now we're at $226 per share. So if I do a little bit of algebra here, 15 times, the 226 gets you to a level of about 3,400. If we saw, sort of the lowest that we've seen on a forward PE multiple basis over the last decade, plus at 14 times, that puts a level of about 3,200. So where could that valuation-based level of support be if we break through 3,700? Could be in that 3,200 to 3,400 range.

On the next slide, one of the things that I think Phil and I wanted to highlight is that there's been a lot of difference between the top-heavy component of the S&P 500 year-to-date and sort of the average stock. And what we're looking at here is, you see the S&P 500 index in that table on the right, which is a cap weighted index. So sort of the bigger names in that index carry a heavier weight. And then we're looking at the S&P 500 equal weight to where we equal weight every one of those names. And what you can see is year-to-date, and over the last several weeks, the equal weighted S&P 500 has materially outperformed that cap weighted index. So the average stock underneath the hood is doing far better than that capitalization weighted index.

Phil: Which is a reversal from some things we've seen in some recent years in which the top-end of the S&P was pulling the S&P with it. Really, what we're seeing on the upside, on the downside is we're seeing some broadening out, which is interesting.

Brent: Absolutely, on the next slide, I think one of the things that we also wanted to highlight is we espouse diversification, Phil, all the time and the way that we think about building portfolios. Well, has diversification even worked? So what we're looking at is here's a little bit of a look underneath the hood of other asset classes. And what they've done year to date in gray, we've highlighted the S&P 500 down 18.2% through the 10th of November.

Phil: On an annualized basis.

Brent: On an annualized basis, right. Cumulative return, -15.9%. Right, when you run your eye down, let's just focus on the cumulative return just to make the math easy. On that middle column, you can see mid-cap, mid-cap value, small cap, small-cap, value, even AG bond. Everything's got a negative side except for inflation.

Phil: Right.

Brent: But diversification has worked year-to-date. When we take that out further, on the next slide, but we think about longer term and longer-term cycle. And this is where we can focus on that far-right column on annualized return. Again, when we talk about something that everyone highlights, which is that lost decade '99 through 2009, large cap stocks for an entire decade, annualized at -1%. So did that mean you get out of stocks? No, it meant that you diversified. As you go down that same list of components, mid-cap, small-cap, value, core, even developed in international stocks developing did significantly better anywhere between 7% to 10% better, sorry between 4% to 10% better per year over an entire decade. Diversification, not only over the short term is work, but over the long term, which I think is important to remind everybody listening is, the way that we build portfolios is always looking forward and every single quarter dynamically reallocating our portfolio if necessary to be reflective of what's coming down the pike, not allocating based on the past. So again, dynamic approach, forward looking capital market assumptions, looking ahead is what we do to drive the boss.

Phil: Right, it's been a tough period to argue for diversification, but historically it obviously works. So let's turn to the earnings picture on the next slide. So one, we've talked for months about the fact that earnings revisions need to come in and earnings numbers need to come down, and we finally are starting to see it. What happens is analysts during Q3 earnings season tend to really sharpen their pencil on the next year.

Brent: That's right.

Phil: In this case, 2023, why? There's more company guidance and the next year is imminent. So what we have seen is earnings growth numbers are coming in quite a bit, 5.3% growth for this year, 5.8% for next year. That number for next year was north of 7% not long ago.

Brent: It was 10% at the beginning of the year.

Phil: That's right. So we are seeing earnings revisions come down. That can actually be a pretty good thing for markets. We'll talk about in a moment because reality is coming into the marketplace. So let's talk about that. So earnings on the next slide. Earnings are expected to grow next year. But let's say we do have a protracted recession and we do see earnings decline. What could that look like? So on the left side, you're seeing peak to trough decline in the last 12-month earnings for the S&P in the 12 recessions since World War II. And what you'll notice is the median is -13%, which honestly strikes me as a little low. And the reason is, is that in our recent experience, not counting the pandemic, '08 and 2001, really dramatic.

Brent: Dramatic.

Phil: Yeah so recency bias but there are definitely recessions that earnings contractions are pretty modest as you can see there. So what does that mean for markets? Well, something you hear a lot sort of, out there in the press., et cetera, is well, earnings are still coming down. And what's implied is the market's going to move with earnings. So that's.

Brent: Yeah, should I be concerned?

Phil: That's right. And it's not really what you see historically. We're showing that on the right side. So various phases of a cycle, despair, hope, growth, optimism. Where have we been this year? The despair phase, as you all just looking at Britt's face, I can tell you that's true. And what is it? That is when price return really contracts. So think early 2020, think about this year. But really PS is actually still growing and earnings, I believe, are now growing this year. They grew in 2020 as a very compact period, but we're still growing early in the year. You have not yet gotten what the market is seeing forward looking into earnings. Now the next phase is hope. What's interesting is in that phase that the gray bar here is declining, earnings have caught up with what the market has already seen.

Brent: That's right.

Phil: But the market's rallying in the future. It's looking through the fact that earnings are declining. That's when you tend to see a rally. Recent example, of course, is the rally from early spring of 2020 when we were still all at home. And the market's moving up very dramatically.

Brent: 4 and 1/2 months you recovered all of your money after that 34% decline and entered the year positive 18.4%.

Phil: Right.

Brent: Who would have ever thunk it?

Phil: That's right. And look, that was a unique period. But past periods, as we're showing here, do rhyme with that. And then you get growth and optimism phase. These are longer phases, as you can see in the parentheticals there. This is more once you're in a sustained expansion. But markets obviously still do tend to trend, trend higher.

Brent: Absolutely.

Phil: So we obviously got a lot of questions, we got a lot of questions, period. But we a lot of questions on—

Brent: I can see them piling up on the side, yeah.

Phil: On midterms and we wanted to address that, address that here. So first, it does, after a protracted period, it does, it is confirmed that Republicans have the house. So we do have divided government. Democrats have the Senate. Both houses of Congress are pretty narrow. So, so certainly slim margins. But you do have divided government. As a reminder, how do markets perform after midterms, which where we are now finally after midterms, they tend to perform well historically. So the upper left here, you can see the vertical line, that's the date of the midterm, markets tend to actually be pretty choppy in the months prior. But post, you do see that line move up. Still choppy, but you do see an uptrend. And if you just look at the 12 month return after midterms in the bottom right, since 1950, the market has been up in every, 100% of observation. Every midterm, 12-month return has been positive, and the average is 15%. Now.

Brent: Small sample size.

Phil: Yes, that's the caveat we always have to give. I mean, it only happens every four years, but it is interesting. You get past that certain that uncertainty of midterms markets tend to perform pretty well. So if we flip ahead, what about the current construct of government? How does that bode historically? Again, small sample sizes, don't get too carried away. But if you go back to the 1800s, right, a pretty long period, coincidentally, the best performing period is Democratic senate, Republican House, Democratic president.

Brent: Which is where we are.

Phil: Which is where we are. So when you think about makeup of the government, not necessarily a bad makeup in terms of what we have today.

Brent: Yeah, from a market perspective.

Phil: That's right.. That's right. From a market perspective. So the right side, this is sort of the seasonality, I guess we would call it, of a presidential cycle. What you do see is markets have historically been the strongest in the third year of a new president's term. That kind of begins, if you look at that green box in the fourth quarter of the second year.

Brent: Yeah, right where we are.

Phil: Which again ties to markets doing well after midterm.

Brent: Exactly, exactly.

Phil: So interesting, if you believe in seasonality of these sorts of things, there are some positive returns there. So looking ahead to the next slide, what else might be drivers of market return? Well, one, markets tend to do pretty well after the Fed's final interest rate hike. We are not there yet. That may be second quarter of next year. If you believe futures.

Brent: Yeah, this is what the market has been debating all, for the last couple of weeks. Are we here? Are we here or when are we going to get there?

Phil: That's right. And much like the mid-term things you do start to wonder if markets know this and there's a little bit of arbitrage happening, but the market knows that generally getting to the last hike is pretty important for the stock market, as you can see here. So moving along. What about inflation? Right, can markets perform in different inflationary environments? How do they perform? So here, let me explain the chart for you. We're showing the average monthly S&P 500 returns over the long term under different inflationary conditions. So the first bar, that is inflation above 4% and rising. That's where we've been this year. That is, obviously, the worst performing environment. That is you have inflation that's high and accelerating. That's problematic. What's interesting is the second-best performing market in various environments is what we believe we are in now, which is above 4% and declining. That's in the green box, tends to be a pretty good market. That is because the directional vector we've been talking about, the market is saying, okay, we're coming back down. That's why if inflation were to reaccelerate, that's a real problem. But where we are today, we think that could perform pretty well. It is why the S&P rallied 5.5% on the day of a disappointing or a lower-than-expected CPI report.

Brent: That's right.

Phil: I say disappointing, low, but very good for, for markets. Not too surprising. Far right, the best performance below 1 and 1/2 and declining. So that's very disinflationary. Markets, markets love that.

Brent: Well, and Phil, a question that we get asked all the time is, you know, man, the markets have really been volatile, whether it's equity markets or fixed income markets. You know, what's an investor to do? Maybe, maybe I should just get out of the markets. Maybe I should just sit on the sidelines and just wait for everything to settle down. So we want to show you this slide and we're going to keep showing you the slide until you're tired of seeing it, because we want to tell you how bad of an idea that is to ever do. So what we're looking at on the left is if you invested a hypothetical $10,000 in the S&P 500 30 years ago, back in 1992.

Phil: Right.

Brent: You held that. And if you think about that period of time, there's roughly 250 trading days in the year, 30 years. That's roughly 7,500 trading days. If you basically just stayed long invested in the S&P 500 for those 30 years, your $10,000 would have grown more than 20x. $208,000 basically at the end of that. Now, if you go to the bar on the right, if you missed only 10 of the best days out of that 7,500-day sample, you had less than half of those dollars.

Phil: Right.

Brent: That is absolutely incredible, Phil. If you go to the bar right over where you miss 20 of the best days out of that 7,500-trading day sample, you had almost 3/4 less. So the question is, well, jeez, Phil, Brent, what is the probability of that actually happening? Well, look at the callout box that you see on the slide. Nearly half of the S&P 500's trading day, best trading days occurred during a bear market. Another 28% of the S&P 500's best trading days occurred in the first two months of a bull market when no one knew it was a bull market. So a full 76% of the S&P 500's best trading days occurred when none of you would ever want to be an equity market investor. So the moral of the story is its time in the market, not timing the market that leads to accretion of wealth over time.

Phil: And if you need a recent example, it's the day I cited.

Brent: Yeah.

Phil: The CPI report day from last week. Market's up really big. That might be during a bear market. Maybe we're entering a different phase. We don't know that yet. But look, 5 and 1/2 percent, there's years. That's a really good return for a whole year. I would have taken it this year.

Brent: Yep.

Phil: So just a reminder that this does happen and it's very hard to time markets.

Brent: So let's bring this home, Phil, and let's talk about our bottom-line views on markets. Let's start first with the consensus and we're looking at the 12 months from now forward bottom-up price target for the S&P 500. So that's not a top-down macro view. That's, you know, analysts looking at each of the individual companies and doing their bottom-up forecasts. Right, putting that together, roughly about 4,500 on the S&P 500 12 months from now, which I'd love to take. That would be great. Or about a 13% return. On the bottom, we only have six weeks left here, but our price target on the S&P 500 has been about 3,800. Why the confluence? We believe that earnings would be below consensus estimates and that the PE multiple would be relatively unchanged from its current level. A lot of moving pieces as you highlighted nicely with earnings. I highlighted on multiples, a lot of moving parts.

Phil: Yeah and look, 3,800 with six weeks left. It's kind of a lame duck price target.

Brent: That's right.

Phil: We will be in our Outlook in December, initiating a 12-month forward price target. So, so those numbers will be updated. We just wanted to include it today. But we would never say we know where markets are going in a six-week time frame.

Brent: Absolutely, so, Amy, with that, I can see we have, that's great, we have lots of questions. Why don't we jump into the Q&A?

Amy: Yeah, thank you, Brent. Thank you. Phil. We do have a number of questions. If you'd like to ask a question, please use the Q&A or the chat feature on the right-hand side of your screen. Phil, first question is for you. At what level of inflation is the Federal Reserve anticipated to then hit the pause button on rate increases?

Phil: Yeah, it's a good question. A question we get a lot. So if you believe Fed funds futures, it's about 5%. And remember, the Fed has a range. So you could argue it's 5% to 5 and a quarter.

Brent: It's been so volatile.

Phil: Yeah, but, but roughly call it 5%, the top-end of the range right now is 4%. So the effective rate is 3.85% or so. So what does that mean? Well, it really goes back to this chart we, we show that Amy has pulled up here, which is, is 5% high enough to get the level of CPI below 5%? And Amy, if you go to the other chart, slide 7, and you believe consensus, well, that's second quarter of next year. What's interesting is when do Fed funds futures peak at 5%, second quarter of next year.

Brent: That's right.

Phil: So if you ever wonder if markets are paying attention, markets are paying attention to what is out there. So does that happen? I hope so. That's gold.

Brent: Market participants are hoping on that.

Phil: Yeah, look, if there's bias, it's probably bias towards the Fed going higher than futures, say, than lower. And that's because of what we've seen the last six months. And the Fed's really telling us that with rhetoric to remind you all, the December 14th Fed meeting, they released their economic projections, which they have not done again since September. If they, in that, they give a median estimate of the members of the path of the Fed funds rate. If that comes in well above 5%, futures will reset that day. Right, so you have to take some of this stuff at what it's worth, which is, was markets trying to price something. But, look, if inflation were to march lower below five second quarter and the Fed's at 5%, that could happen. I think there's upward bias, though, to the Fed funds.

Brent: Oh, absolutely. And again, the Fed has reminded us time and time again that they're going to remain data dependent.

Phil: Right.

Brent: And we have to look at what that series provides. Right, so I think the one thing that is for certain is that we're likely to have continued volatility and rates in currencies and in equity markets until we get some type of solidification on the broad directional vector, which isn't going to take one or two data points, it's going to take many data points to actually get the Fed where they need to be.

Phil: Yeah, I don't think the Fed, you know, the Fed was late to the party. I don't think they now are going to say, okay, we have two or three good CPIs.

Brent: Yeah.

Phil: What, we're going to.

Brent: It's a credibility issue if they did.

Phil: Now, they can slow the pace of hikes. Right, and there's a reasonable, right now, futures are pricing 80% chance of a half point hike in December. That would be a slowdown from a ¾-point hike, what we've seen in recent meetings. So there's a chance that they slow down. But slowing down to me, that's not a pivot.

Brent: Yeah.

Phil: That’s not a pause. That's just slowing the pace of hiking.

Amy: So Brent, we have several questions that are aiming towards the same direction around a looming recession. At what point do you just get out, cut your losses and move on? What steps are we taking from an investment strategy positioning standpoint in anticipation of a potential recession?

Brent: See, I told you, Amy, every webinar we get that question about whether or not we should step out of the markets. And I think the first thing that I think every investor has to do that really, I think Phil, helps from a behavioral holistic perspective, helps you deal with everything that's going on is having a financial plan, right? That sort of helps anchor what you need to achieve to be successful in all your goals and objectives. And that's whether you're an individual or a business, you need to have a plan. Again, as we highlighted, timing markets can prove incredibly dangerous. Virtually no one can do it because if there did exist a person or a firm that could time when to get out. And when to get back in, they would manage a lot of money, and they would charge a lot for it. It doesn't really exist. It's time in the market, not timing the market that matters.

But to that last part of one of the three questions that came in on that, what are we doing about it? I think that's sort of the essence of our portfolio construction process and optimization protocols is that we develop forward looking capital market assumptions and we use a sort of a three-year forward-looking viewpoint to understand what's coming down the pike when, what does that look like? And look at the relative disposition of all those asset classes and where we think our clients need to be in which asset classes at the right time to be able to successfully navigate where to be, to grow your wealth over time. We do that for you every single quarter. Doesn't mean that we trade every single quarter, but we're evaluating this every single quarter to make sure that we're putting your diversified global multi-asset portfolio on the right firm-footing for what's to come.

Amy: Thanks, Brent. Phil, next question is around the holiday season and consumer spending. Are there any early indicators for what that might look like and what that might mean if it's contracted, what that might mean for next year?

Phil: Yeah, that's a great question and a few early indicators I can point out. One, we mentioned retail sales came in better than expected. But again, in the details, you know, consumers are spending a little bit less on discretionary items, which is not necessarily good for holiday spending.

Brent: Shifting preferences.

Phil: Yep. And we've gotten retail earnings lately, mixed bag, some actually pretty surprisingly good results today, combined with some negative results earlier in the week. So I call that, let's call that mixed. Looking at some survey data around the holiday season, there's a few interesting things. One, if you bring it all together, consumers are saying they want to spend roughly what they spent last year. Now, the thing to remember is they would probably mean nominal dollars. If you were to ask that question.

Brent: From a real basis.

Phil: On a real basis, it's less because there's been inflation, which makes some sense. Right, people are still working. They have jobs, they're going to spend something, but in real terms, probably less. The other thing that I think is really interesting is that consumers, something like 70% of consumers are saying that they are going to wait for promotions, they're going to wait for discounts. We have heard from retailers for months now that for many of them, inventories are elevated. So we've known there was going to be discounts. It does look like there will be promotions this holiday season. Now, of course, can be bad for margins, for retail margins. The market already knows that and the market's priced out a lot of ways. But it's actually good for disinflation, right? If you want inflation to come down, promotions are good and good for the consumer, not necessarily good for the company. So I think if you look at this holiday season on net, it's probably going to be a pretty eh, holiday season in real terms, certainly. But I do think that there are going to be winners out there as probably those who aggressively, aggressively discount.

Brent: I would agree.

Amy: Brent, no shock here. We're getting some questions around some things that have happened in the news, especially around cryptocurrency, with all of that happening, all the recent news. Do you think institutions will likely back away from cryptocurrency? What do you, what are your thoughts?

Brent: Yeah, look, with the recent debacle that we've had with a major crypto exchange, it's no wonder why we're getting the questions. And there's certainly a lot of details to unpack and a lot of postmortems that will likely come from all of this. But I honestly believe, a couple of things, Amy. Number one, this is a watershed moment for cryptocurrencies and digital currencies. I personally, I don't believe that they're going away. But what it does mean when you have something like this happen is that you have some big things like investor confidence, investor safety, safely custodian my assets is, in our opinion, has always been a really important thing. I think it's really coming to bear with the situation at hand today. And then I think obviously, you know, certainly post midterm elections, change in government. I'd say there's sort of a bipartisan support on this for potential further regulation, which doesn't necessarily mean it's a bad thing when you have watershed moments like this.

So sometimes asset classes and securities come out on the good end. When you have that watershed moment, when you have this type of situation, you end up with more regulation. It lends itself potentially in the future to more safety, security, oversight, regulation that gives investors' confidence if, in fact, they choose to own something like this, that at least their money's safe, at least it's being thoughtfully overseen and regulated to the degree that it needs. Way more to come. And I think it's way too soon Amy, to opine on anything. But it is absolutely a watershed moment. More to come.

Amy: Phil, now that we have the election outcome, does that give us a better indication of what to expect in the markets?

Phil: You know, it's always interesting and we talked about some of it, so I won't repeat myself fully. But if you turn to page 28, Amy, it is generally a good period for markets. The 12 months after, after a midterm election. Right, up 15% on average and of each of the midterm since 1950. Now, we generally are loathe to trade politics because the truth is that that's not a great return generating.

Brent: It's like predicting the outcomes.

Phil: Yeah.

Brent: How does that work out?

Phil: Yeah that's not necessarily what, we can point to many years that politically you'd be surprised how well the stock market did given the politics. Right, so we don't think that that's really the one thing to trade on. But there is something about getting past the uncertainty that helps and also divided government and this form of divided government, as we showed previously, the markets tend to perform pretty well. So it does mean that in Washington, if something's going to get done, it's going to take negotiation and that's something to watch. Something to watch next year will be the debt ceiling debate.

Brent: Yeah.

Phil: Do we get a repeat of the 2011 period, which drove a lot of market volatility around that debt ceiling debate?

Brent: Yeah I mean, we know you're changing of the Speaker of the House, thinner majority in the House. You could end up with some impasses that might lead to some things that you wouldn't want to see. But again, that's what politics is. And again, we'll focus more here Phil, on the market side, which we probably better understand than the political side of the equation. But again, historically, it's been a good thing.

Amy: Let's do one more question before we wrap up today. This is a really, really good question here. If a recession were to happen in the next 12 months, how long would you expect it to be and how difficult would it possibly be?

Brent: Yeah I mean, I think it's well, it's hard to tell whether or not we will fully go into a recession. There has been some resiliency in the labor market and some of the retail sales and economic data that kind of opens the door, just maybe a little bit of a crack, Phil, for a soft landing. It was, you know, triangulating to that softer landing was getting harder and harder every day with what we saw going on. That possibility is still out there. Again, we do believe that at least going into this situation, consumers and corporations are in arguably the best shape that they've been in from a PNL balance sheet and cash flow perspective than they were, let's say, going into the Great Financial Crisis.

So at least going into this, it's almost like getting ready for a hurricane. We're a little bit more prepared, the extent to which we actually have a material downturn, time will tell. How deep and protracted it might be, hard to tell at this point, and I'd hate to opine on that. But again, at least going into this, we seem to be better prepared on the consumer and corporate side of the equation. And again, to me, it's always about the labor market. If consumers are gainfully employed, it's a little easier to weather this storm than it is if you're not.

Amy: Well, Brent, Phil, thank you both so much for answering questions for us today and presenting all that information. We'll go ahead and wrap things up. I want to let everyone know, we will be delivering our 2023 Market and Economic Outlook in mid-December. That's going to come directly to you. There's no sign up needed for that. We're going to send that out to everyone in the mid-December range. Just as Brent highlighted at the top of the hour, we just want to thank everyone for, in the spirit of the holiday, thank everyone for giving us the opportunity to spend this time with you each month and giving, give you some of the thoughts that we have and hearing some of your questions. Just, on behalf of all of us here at First Citizens Bank, I hope you all have a happy and safe Thanksgiving holiday. And we'll see you again soon.

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