Making Sense: April 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. I'm a strategist here at First Citizens Bank and I want to welcome you to today's webinar. Before we get started, there are a couple of housekeeping items to get through.

First, this webinar is being recorded, and a replay will automatically be sent to anyone who is registered. 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 try to keep our discussion very broad, so if you have a specific question about your financial plan or you're not able to answer, or we're not able to answer your question during today's webinar, 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, it's great to have you back with us this month. I know you've been doing a lot of traveling, but it's great to have everybody back at home base this week.

Brent: Well, great, Amy. Yes, thank you so much. It's great to be back. And good afternoon, everyone. Hope you are well. Phil, I can't believe it. We're past Tax Day, at the end of April already. I saw that the Treasury basically collected $17 billion less in taxes on April 18. And I think the question I need to ask you is, did you actually pay your taxes? I can't imagine that we'd have such a shortfall of your actually paying your taxes. But joking aside, Phil, you and I have a lot to cover today. So we're going to give you an economic update. We're going to cover four specific areas. We're going to talk about the trajectory for US growth and global growth, the probability for recession over the next 12 months. We'll get into a little bit of that. We'll talk about the path forward for rates and Fed funds. We'll talk about the path for inflation. We'll also talk about the labor market a little bit, a little bit of unrest there. And certainly from a market update, we're going to get deep into where do fixed-income markets go, where do equity markets go? So let's jump right in.

And certainly we are seeing, Phil, an economic slowdown in the United States and abroad. Manufacturing is now in contraction territory. We've had new orders deeply in contraction. Services, while still in expansion, is moderating significantly lower from the March of 2021 high. Labor market is a little bit uneasy, 245,000 initial jobless claims. It's up.

Phil: Right.

Brent: Right, when I think about commercial loans and leases, we saw, Phil, the sharpest contraction in 50 years in commercial loans and leases in the last 2 weeks of March. So when we say financial conditions are tight, they're tight.

Phil: They're tight, for sure.

Brent: Yeah, earnings and profitability decelerating from highs. When you look at the graph, I want you to focus just specifically on that US line item. When we came into the year, expectations for growth were about 40 basis points. Well we've ticked up from that. So despite all of that, expectations are higher. April data is looking a little bit firmer. So by and large, we'll talk in a minute about the probability for recession. But what that does tell us is that the probability for a hard landing has moderated somewhat. So we do believe that if we do have a recession, it's likely to be shallower or more moderate than what was expected coming into the year.

To that point, on the next slide, Amy, when we talk about the last 16 months, we've seen the probability for recession, Phil, 1 year out, started at almost nonexistent as we came into 2022. Now sitting at, geez, 65 percent. We've been between 60 and 65 percent probability of recession now for some 5 months. And again, as we've started to get in some data that shows a little bit more moderation before this April data came in there, that probability of recession has remained high. I know that we're at 60 percent and the expectations for a recession are elevated. But again, we believe it's a much shallower, or moderate contraction if we have one, than a deeper protracted one.

Phil: Right so, so, while recession probability has been fairly steady in recent months, as we flip ahead, what has changed with concerns within the banking sector is a number of things. One thing we've noticed, of course, is expectations around the Federal Reserve.

Brent: Right.

Phil: Right, so we're showing here, is what is the implied rate from the futures market of the federal funds rate on a given meeting date? So May all the way out to January of next year, as you can see here. On March 8th, right before the banking concerns really arose, the market was expecting the Fed would continue to hike pretty dramatically.

Brent: More times.

Phil: Multiple more times and if cutting, very slightly late in the year. And what we've seen, and these numbers have shifted even in the time between March 8th and April 17th, as we're showing here. But, expectation now is one, 80 percent chance that the Fed hikes next week and then multiple cuts later in the year.

Brent: Yeah, I think it's incredible. I mean, you're looking at a terminal rate, right, on March 8th of almost 5.7 percent. Now you're looking closer to 5.1. So just a couple of weeks had an incredible change. And let's hope as we get later in the presentation, you know, again, like you said, our belief is that the Fed keeps rates higher for a longer. We don't see that chance of a cut until sometime the first half of—

Phil: Yeah, we're a little skeptical that the Fed would do all this work and then begin cutting very quickly.

Brent: Exactly.

Phil: You know, this summer, for example. We'll see. Something could break, hope not, but we tend to think that the Fed will keep rates elevated for some time. As we move ahead, what are we showing here? We're showing market pricing of the Fed terminal rate. That is the gold line. And what that is, it's a fancy phrase, really is just means, well, where's the Fed funds rate going to end this cycle? And what we had when you look at market pricing of the terminal rate versus the Fed funds rate itself, we had a really big spread, really since this time last year. And what's happened is that spread has narrowed. So what is that telling us? It tells us that the Fed is closer to the end of this cycle than the beginning. We think they hike next week, right, quarter point, but likely pause after that. We have had a huge amount of hikes the last 12 months, and the Fed wants to see that feed into the economy and see what impact it's having on Main Street.

Brent: Given how, you know, diverse we've seen the expectations between markets and the Fed, it does scare me a little bit that they've converged to this, sort of that same level. It makes you want to, sort of, take the under as it relates to this specific call. But we'll have to see. And I think one of the things that are really important on the next slide, Amy, is where does inflation moderate from here?

Phil: Right.

Brent: And what you're looking at, in the gold line, we're looking at headline inflation. And in the gray line, you're looking at core CPI, which is minus food and energy, the more volatile components. And what you can see is we've had a significant moderation lower in headline when we hit 9.1 percent in June of last year and we've fallen for 9 consecutive months. So we've seen that moderation in inflation. Where it's been a little bit sticky, Phil, is on the core side of it, right? Owner-equivalent rents, rents overall, primary rents, have been a little bit stickier in the governmental data, though when we look at either the Zillow rent index or Redfin, we have seen significant moderation in rental prices. When we look at more of the public databases, they just have not yet found their way into the governmental data. But the overall trajectory has been good and continues to moderate.

Phil: It's been lower. But if you're the Fed, you don't like seeing that core CPI number above the headline number.

Brent: Yep.

Phil: The first time in a number of years. So again, we need to see that, see that core number come down just as the headline is.

Brent: Absolutely, and when we talk about the path for inflation on the next slide, Amy, what we're looking at here are, in the gray bars, is what's actually occurred. And in the gold bars are the economists' consensus expectations as to where the path of inflation goes from here. And what you can see in those first three yellow bars, which is the rest of this year, is continued moderation lower in inflation, though, when you look at that Q4 of 2023, 3.3 percent, still is nowhere near, Phil, the Fed's expected or targeted inflation rate of 2 percent. Even when you go out to the end of June of 2024, 2.7 percent is materially above that 2 percent target rate for the Fed. So more road to hoe. And again, another reason why we believe that they're likely to keep rates higher for longer and not reverse course and start cutting rates unless there's something major that happens.

Phil: That's right, and the Fed's not going to back away from their 2 percent target for inflation, just as we've had elevated inflation. But the truth is, the Fed needs to see a decline and if this were to play out, this is a positive—

Brent: Absolutely.

Phil: For markets.

Brent: On the next slide, Phil, this is the question that we get from clients all the time. When is the Fed going to stop or, hiking rates, and when are they going to start actually cutting rates? So to cut to the chase, the Fed has never paused or stopped hiking rates until Fed funds was above the rate of inflation. And what we're showing here in the gold bars is the upper bound of Fed funds. And in the gray bar, we're looking at headline CPI. And you can see that bar on the far right, where right now Fed funds is on top of headline inflation. So the Fed is really at a crossroads here. Do they hike one more time and put the knife into the ribs of inflation? I'm from New Jersey, so I'm sorry, little, little visual there. Or do they sit back and wait for inflation to moderate below that level of Fed funds? Time will tell, again, we believe that they'll hike one more time, potentially in May. If not, they might pause and wait until June. But by and large, we're kind of at that inflection point. And I do believe that May or June will likely be the last rate hike if in fact, they do stop then. But again, time will tell.

Phil: So that's the first part of the Fed's dual mandate price stability. Let's talk about full employment.

Brent: Yeah.

Phil: The other side, the Fed's dual mandate. So the labor market remains incredibly tight.

Brent: Yeah.

Phil: Very strong. There is some loosening. We want to talk about that. But the headline numbers, 236,000 job gains in March, 3.5 percent unemployment. So when you look at the headline, you say, wow, still very robust.

Brent: It's crazy. 315,000, 6-month moving average right, way above.

Phil: So, but in the detail, some interesting things are happening. So one, we get questions every presentation we give on participation, right? Often hear from our business clients that say availability of labor is still a real problem. So what's happening in participation? So if you look at participation for the entire population on the left side here, this age 16 and up. First, participation has improved. The workforce has risen from the lows of the pandemic, but we're still below the previous high. And why is that? Well, this includes baby boomers, for example, who are retiring and other structural people leaving the workforce. What's interesting, though, on the right side, this is prime age participation, so age 25 to 54, very important component for the labor market. And for the economy as a whole.

Brent: The primary driver of tax receipts and the primary wage driver of everything in our economy.

Phil: That's right. What's interesting there is participation is back to its pre-pandemic level. Obviously, that is a good thing to see. We still have a long ways to go. It's a very tight labor market, but something that we take as a positive. Speaking to that point on the next slide, job openings. So job openings peaked at 12 million—

Brent: It's incredible. Incredible.

Phil: 12 million jobs. Look at what that is versus history. Now it has fallen, it's 9.9 million. We're seeing layoffs in certain sectors, for sure. Certainly there's a little bit of loosening here. Still very tight.

Brent: You're double the long-term average, at 9.9 still.

Phil: And similarly on the right side, job openings to unemployed. This peaked about two. So that means two job openings for every unemployed person.

Brent: Yeah.

Phil: That is pretty incredible. Labor market, that has fallen to 1.7. So again, some of this loosening, rise in initial jobless claims and we've seen this year. We are seeing a bit of loosening of the labor market. That is good on the inflation front. It may be a double-edged sword when we think about consumer spending. And we can talk about that in a moment. So this all feeds into wage inflation on the next slide. So first, it peaked around 6 percent last year, has fallen pretty consistently, much like price inflation, consumer price inflation, to 4.2 percent. That's still well above the long-term average of 2.9 percent but an improvement. Much like price inflation, wages are softening in terms of wage inflation. Still elevated, but improvement.

Brent: Yeah, and I think it's incredibly important for everybody listening in to understand the fundamental data as it relates to the labor market and the consumer. Remember, more than 72 percent of US real GDP is driven by the consumer. 68 percent is consumption. Another 4 percent is housing. So as goes the consumer, as goes our economy. And when you think about 90 percent of Americans spend 99 cents of every dollar of monthly net income, as long as they're gainfully employed and are making a decent wage, we believe that the economy should be able to hang in there so hopefully, if we can keep the labor market still buoyant, I think we should be okay, and have a lot more moderate to slow—

Phil: And feeding back to the concept of inflation probability being 60 percent from us and not 80 or 90 percent, well, the consumer remains fairly strong. There's some cracks, but fairly strong.

Brent: That’s right. So why don't we transition, Amy? And let's just talk about the market and where we go from here. Phil, let's start on the fixed income side of the equation. And we've gotten a lot of questions from our clients as to, you know, where do yields go from here? Let's start first with the Treasury market. You can see, you know, pre, you know, banking dilemmas that we saw back on March 8th, we saw the entire Treasury yield curve was significantly higher. Right, in a matter of a number of weeks, we've seen significant fixed-income volatility, significant Treasury yield and price volatility. And just look at that middle column, see how significant we've had in a drop in yields across the entire curve. And remember, look at that 10-year line item, 10-year Treasury yield line, I mean, we were at 4.24 on October 24th of last year and we're now, what, at 3.43-ish today? Right so continued moderation, lower and Treasury yields. From our lens, we do believe that while rates will remain volatile, we believe that we are past the highs in yields on the Treasury side of the equation. The investment-grade corporate bond side, we'll have to talk a little bit about that, at least from a Treasury perspective. We believe that we're past the highs in yields.

So on the next slide, the good news is after a lot of the pain, Phil, that we saw in the first three quarters of 2022 with treasuries, it's nice to see that we've had two consecutive quarters of positive Treasury price appreciation, significant move up in this first quarter here. More than 3 percent move upwards in the Bloomberg Barclays Treasury index. So good to see. Hopefully some of that pain is behind us. And we do believe potentially, while it will be volatile, yields will continue to fall.

Phil: And if you widen that out to something like the aggregate bond index, also a really good quarter.

Brent: Absolutely.

Phil: So this is indicative of what you're seeing across the bond market.

Brent: On the next slide, when you look at the chart on the left here, right, I think it's incredible. The gold line is the 10 year. The gray line is the 2 year. Look at where we were during the pandemic and into 2021. And just look at that incredible move up in yields. If that encapsulates the incredible movements in monetary policy that we saw the Fed put into place, and I know that you're going to get into a little bit more detail later on, but just incredible move upwards in yields. And you can see the more recent part coming back down. A lot more room to move back out. We certainly don't believe that we're going to get back down to the rates that we saw during the pandemic, but certainly a move lower. When you look at the graph on the right and you look at the 2s/10s spread, which is nothing more than the yield differential between 2-year notes and 10-year bond yields, we saw a significant inversion this year. We hit, as negative as 107 basis points. We've come back a little bit. Normally, that yield curve inversion when it drops below zero tends to be a harbinger of bad things to come in the economy. I think time will certainly tell. It has moderated up a little bit. So we'll see as it gets to, you know, being a recession and what that looks like.

Phil: So sticking to the fixed-income market on the following slide, what happened with some of the concerns in the banking sector in March? Well, this is, we're seeing volatility of bonds and volatility of stocks. Your bonds are the gold line. What's incredible is this spike in bond volatility compared to its recent history last year, is really dramatic. What's interesting is stocks, yes, volatility spiked, but look, still below the previous levels we saw last year. So a lot of the concerns found their way into the fixed-income market. Now, what's good to see is volatility in both these markets has come in recently, but something to point out in terms of really a lot of concerns within fixed income.

So if we flip ahead, what is this we're studying here? This is investment-grade option-adjusted spread. So that's a lot of words. But what it is, is it's what is the spread of the yield on a typical investment-grade bond versus the risk-free rate, versus treasuries? So what it's saying is, when this number is higher, it's saying that the market's demanding more of a premium for a corporate bond than a Treasury. So, for example, 2020 right, risk on, risky period, a lot of uncertainty, that premium rose. What's interesting is if you look at the most recent period, March of this year, you see a little spike up there. We hit 182 basis points, 1.82 percent but you stayed below where spreads were, even last October.

Brent: Yeah.

Phil: So what's interesting is, is really what felt like quite a dislocation, markets did not show the level of panic you might have expected. In fact, markets stayed pretty contained.

Brent: Yeah, I mean, compared certainly to what you just pointed out with the pandemic, if we took this all the way back to the Great Financial Crisis, you're looking seven, 800 basis points over treasuries. So we've been, you know, relatively sanguine as it relates to corporate bond spreads, given the perceived volatility and noise going on in the market.

Phil: Hopefully markets are telling us something that this will be resolved.

Brent: Absolutely.

Phil: So as we flip ahead, look, we've talked about yields have fallen, but the truth is, yields are still very attractive. Right, we hear this from our clients every day. We're showing end of 2021, right, we showed them the chart, still very low yields, 2-year treasuries at 73 basis points versus where we were last week. And I won't read all these numbers to you, of course, but what you'll notice as your eye moves down the line, there is yield in the marketplace.

Brent: That's right.

Phil: This is something we've talked to clients a lot about and heard from clients a lot. Now, the balance between stocks and bonds is more interesting because you can get return within the fixed-income space.

Brent: And I think it's critically important when we think about capital market assumptions and forward expected returns, especially in the fixed-income universe. Forward expected returns tend to be not too dissimilar to current spot yields over that duration horizon. So when I look at the AG bond at roughly a 4 and a half handle with a duration of roughly, you know, mid 6 and a half, six, eight, right, you're looking at a pretty good expected return given where we were at the end of the year in 2021, let alone if I went back even further. So again, across the board, whether it's treasuries, whether it's investment-grade fixed income, whether it's high yield, attractive current spot yields, but also manifest into good forward expected returns.

So to that point, let's change gears, Phil, and let's talk about the equity markets. We have a lot of clients asking, hey, Brent, Phil, is the bottom of the market that we saw back on October 12th it? Time will tell. But we are now, and I'm going to adjust this on the fly, we're probably about 15 percent above the lows that we saw in the S&P 500 at 3,577 back on October 12th of last year. Certainly has not been a straight line up. It's been a rocky road. I think when we think about it, if we look at a historical precedent, on average, Phil, the S&P 500 tends to bottom 6 to 9 months before corporate earnings bottoms. Well, where consensus expectations as it relates to EPS on a quarterly basis. Consensus right now has corporate earnings bottoming this quarter. So if that were in fact to happen, it would put October 12th's low right in a reasonable range for historic bottoming patterns that we've seen in previous cycles. Again, time will tell. There's certainly a lot of volatility in front of us, but by and large, we may have bottomed on October 12th of last year. And again, we need to see a good trajectory up in corporate earnings and profitability. And so far, so good. 81 percent of companies reporting already. We have about a third of the S&P 500 reporting this week. Knock on wood, so far so good as it relates to earnings.

Phil: And that 81 percent, those companies have outperformed a lowered bar, but outperformed the consensus EPS expectation.

Brent: Absolutely, so let's get under the hood a little bit, Amy, on the next slide and talk about what's been happening. Let's look at the chart on the left here and take a look at where the returns in the US equity market have been coming from. Phil, it has been mega-cap companies more on the growth side of the equation. You can see down the entire right side of that nine-quadrant box, growth has been outperforming value significantly. And, you know, large-cap growth has been the recipient of much of what's going on. But again, even with that low vix, don't let volatility fool you. Look at the weekly performance and change in the S&P 500. We've had a ton of volatility, both to the good and the bad. And on the next slide, Amy, when we look at the microstructures underneath the hood and you look at the chart on the right, there, sorry, on the left there, and you look at the S&P 500 year to date, cap weighted, you can see 829. I'll adjust on the fly, it's more probably like 7 and change, 7 and a half. Right, look at that compared to the equal-weighted S&P 500. So basically looking at all 508 constituents, equally weighted, you don't have a lot of breadth and depth in the market. And when you look at that chart on the right-hand side, the top 20 largest stocks have added, Phil, $2 trillion to their market cap year to date through April 4th. Just incredible. The residual 480 stocks have only added $170 billion to their market cap. So we've seen a mega-cap run, momentum driven, more growth oriented this year. We do believe that as the year continues to go on, it will be much more volatile, especially going to talk about in a minute the debt ceiling, what's going on. But by and large, we think that might reverse a little bit as we get further in year, but time will tell. So far it's been a mega-cap rally.

Phil: Yeah, but it's been a narrow rally and a lot of the stocks that did not perform well last year are performing this year. So what has the market faced, and what is it facing as we look ahead to the rest of the year? Well, one, the Fed. We talk about the Fed a lot because they really matter. So we're showing past hiking cycles here on the left side all the way back to 1983. The gold line is the current cycle. What you'll notice here is it's an outlier.

Brent: It's incredible, look how fast and high.

Phil: Really rapid hikes. And look, the market is still absorbing this. It takes 12 to 18 months for monetary policy tightening to find its way into the mix correctly. So we're still dealing with this when you think about Main Street and the real economy, it has been a dramatic hiking cycle, but we believe we're closer to the end than the beginning, certainly, and might be even a month away from the end. So how does the market perform after the final Fed hike? We're showing that on the right side all the way back to 1984. So the 6 months prior to that final hike, you can see on the left side, the vertical line is the final Fed hike and then performance following that. What you'll notice is outside of the 2000 period, which we can talk about, market performance tends to be pretty positive and maybe the market has figured this out and that is one of the reasons the market's up this year. Right, but there is something to see here in terms of the certainty of the Fed being done, the market liking that. Now 2000's different. The underline of course of dotcom, and you had some Fed policy change.

Brent: Yeah, I mean, think about that as an outlier as it relates to Fed policy like you just mentioned. What actually happened? The Fed stopped raising rates in the May meeting of 2000, only to turn around by December of that year starting to cut rates. So as we go back to the slide that you covered as it relates to what the market's expectations for potential cuts this year, let's actually hope from a stock market perspective that it doesn't happen because previous analogs, when that has happened, when the Fed's reversed course quite quickly, it hasn't been a good thing for equity markets. So let's knock on wood.

Phil: And what you have to ask yourself is, why is the Fed reversing course?

Brent: Exactly, right.

Phil: Something broke. There is, there's a problem in the economy that is forcing the Fed to cut. So that is certainly a scenario we don't want to see. What else does the market face this year? Debt ceiling.

Brent: That's right.

Phil: We do not give a presentation, this is not talked about a lot, and that's really been true for months now. Here we're showing the 2011 experience. You can see on the right side of this chart, when debt ceiling talks broke down, of course, the stock market traded. What's interesting is even with their big concerns around the Treasury market.

Brent: Yeah.

Phil: People bought Treasury.

Brent: Exactly what happened.

Phil: They saw yields fall. So the playbook would be stocks down, treasuries rally. Of course, every period is created differently. But you do have, of course, this overhang facing us as we enter the summer.

Brent: Yeah, and it's going to be contentious. You're going to be watching television and seeing a lot of professional wrestling as it relates to political jarring as to whether or not they can get together and actually take care of this debt-ceiling dilemma. We certainly started conversations already. While that might be contentious and get more contentious before we ultimately get to a resolution, we do believe that there ultimately be a resolution in time. Again, if we do, God forbid, end up not being able to raise the debt ceiling, we don't think that will likely impact the Treasury market and the capacity to repay. We believe it would start with potential essential services, potentially post office, closing of parks, things along those lines like we've seen in the past, not our failure to repay obligations, but it would absolutely induce a lot of volatility.

Phil: That's right. So what is our view in terms of the stock market? So S&P 500, our 12-month forward price target is 4,100. We've been there for some time now, since December. The truth is the markets basically rally to that price target. Now, as of yesterday, the market's trading just below this price target. Well, we've stuck with it. And the reason is the market's up, depending on the day, 6 to 7 percent on price terms, not total return terms. And we do think there's going to be some bumpy times ahead. Earnings revisions are still coming lower. Then you have the debt ceiling debate. Of course, geopolitical, which you can't really price, but it's out there as well. We just think it's going to be a volatile year and the idea that we're going to march higher consistently, we're a bit skeptical. You will notice, though, we do have a bull case at 4,500 and a bear case of 3,100. We have more downside to our bear case, and upside to our bull case that we felt coming into the year there was, we were facing a lot as a market, and we continue to believe so.

Brent: Yeah, so I think the question that we get an awful lot and on this slide, thank you, Amy, that everyone's been asking is okay Brent, Phil, if we get into a recession, what should I expect for stocks? So what Phil and I put together, I think we put out this piece, I think it was last week or the week before. This is every single recession post-World War II. And what you can see is that on average, Phil, the recession lasts about 10 months, both average and median. So pretty much around there, a little bit less than a year. And then when you look at the S&P 500's performance during a recession, it's been mixed, 50 percent of the time you've had a positive outcome, 50 percent of the time it's been a negative outcome. Average return, positive 3.8. Median observation, 8.8. But what you see in the boxes below the Christmas theme of the green and red there, is when the stock market was positive, you saw significant double-digit returns for equities. When it was negative, specifically, when you look at median observations of negative ends, more flattish, not really a significant dislocation in the midst of a recession. But the biggest takeaway for me personally is if you're an intermediate to long-term investor, like you all should be, look at the S&P 500 performance 1-, 3-, 5- and 10-year cumulative returns post the end of a recession. You are positive 92 percent of all observations one year post a recession with an average return of 21 percent cumulative that one year after. But look at 3, 5 and 10, 100% of observations. 3-, 5- and 10-years post the recession, you saw positive cumulative returns, and you look out 10 years post the end of any one of these recessions, on average you saw almost a 260 percent cumulative return for the S&P 500. So remember, folks, it is time in the markets, not timing the markets, that leads to accretion in your wealth. So again, while it might get volatile over the next several quarters, look at the intermediate, look at the long term, have the right plan, stay invested, likely accretes to wealth. So, Amy, I know that we have a ton of questions. Why don't we flip the slide and talk a little bit about what we have to offer?

Amy: Yeah, we sure do have a bunch of questions, Brent. And just to give everybody a heads up, if we're not able to answer your question, please know that we're going to cover a lot more questions in the coming weeks with this month in our Q&A video. Speaking of this, we hold this webinar every single month. If this is your first time with us, thank you so much for joining us. We also have a number of things throughout the month to keep you informed with everything that's going on. From weekly videos to the week ahead, the longer Q&A videos with questions that we're hearing most often from clients, along with some written commentary throughout. If that's something you're interested in, I'd invite you to sign up on our subscription page by using the QR code on the screen. If you're using your phone for today's webinar, you can also visit firstcitizens.com/wealth and find, find a place to sign up for that subscription there as well. So, Phil, let's jump right in. We've got a number of questions, as we already mentioned. But this person is asking, what are the odds that we'll have a recession and when might we see that occur?

Phil: So our recession probability is 60 percent. Admittedly, we've been there for quite late third quarter of last year, next 12 months. Look, our view is if we were to have a recession, likely it begins sometime back half of this year.

Brent: That's right.

Phil: So, so, why 60 percent and not lower? Well, 60 percent because, one, we're seeing manufacturing activity slow. We're starting to see personal spending slow a bit. You know, we get personal consumption in tomorrow's GDP report and then we get personal income and spending for March on Friday. Retail sales have fallen for a couple of straight months and personal spending, there were signs that it was turning over late in the first quarter. That is very interesting to us. But why not higher? Well, the answer, there's the labor market, right. We've already spoken to north of 70 percent of GDP is consumption and related activities. When you have a good labor market, it's very hard to have a recession. It's one of the reasons we've limped along so long. We've talked about recession probability for over a year now and yet to have had a recession because personal consumption has remained robust.

Brent: Yeah, and I think you nailed it, Phil. And again, even if we do technically go into a recession, given the robustness of the labor market, right, giving that services is still hanging in there, we don't see knock on wood a deep and protracted recession. Even if it were to occur, I mean, just go to restaurants, fly in a Delta lounge, go to your favorite theater or events. People are out and about and spending. So again, we think it would likely be a shallower, more moderate recession if in fact, it were to occur.

Phil: Not to mention corporate and consumer balance sheets—

Brent: Yeah.

Phil:And that fact that we're coming from a low unemployment rate, coming from 3.5 percent is coming from a place of strength.

Brent: Yeah, the lowest in 60 years.

Phil: That's right.

Amy: Phil, let's talk a little bit about the stay on the path with the consumer. Can you talk about what you're seeing with the consumer right now, including delinquency rates and loans, unsecured as well as mortgages?

Phil: Sure, so in terms of the consumer, we've covered it a lot, I think broadly, still strong. But there are some signs of early softening when you look at things like retail sales. Delinquencies are interesting. You are seeing a bit of a rise in credit card and auto delinquencies still pretty low versus longer-term history. Mortgage? I haven't seen much evidence yet of mortgage delinquencies on the rise. We're still pretty early in that cycle. A lot of people locked in a low mortgage rate and a good payment in recent years. So, so we'll see how that plays out. So right now, and then, and then when you think about different quintiles of income, look, we are seeing the use of credit cards, rise. Revolving credit. That's indicative of people that are really being impacted by inflation and a weakening economy. But broadly, in sum, the consumer has hung in there really remarkably well, and that feeds directly to the labor market. So consumption is probably going to be pretty strong in tomorrow's GDP report. Looking forward, I do think there's a little bit of softening, but coming from a place of strength.

Brent: Absolutely.

Amy: Brent, I've got a question here with some pretty specific concerns around geopolitical risk—

Brent: Okay.

Amy: —and how it may pertain to the US banking system. So given all the turmoil and, and, volatility around the world, what is your 5-year outlook for inflation, deficit spending, US tax rates and the domestic bond market?

Brent: Wow, okay.

Phil: That's everything.

Brent: Yeah, alright. So let me hit, so one thing, we're going to be putting out a piece probably in the next couple of weeks on equity market returns around geopolitical events going all the way back to World War II. So by and large, you know, spoiler, the equity markets tend to do well 6 to 12 months after most geopolitical events. We'll put that out there. Rapid fire, through that person's questions, 5-year inflation, right now, 5-year break evens have fallen down to 2.26 percent. We're probably more in the camp of that 2.3 to 2.5 percent over the next 5 years when you think about that geometric average, potentially a little bit higher than what's implied in break evens. But again, getting closer to that Fed's target of 2% inflation, but likely a little bit higher because of the front end versus the back end as you relate to that average.

Phil: I would take 2.4 percent, 2.5 percent. Sounds great.

Brent: Yeah, sounds great. Right in the middle of that. Let's talk about deficit spending, because I've gotten a lot of questions related to the debt ceiling, to about our outstanding debt. So let's just be frank here. There's going to be a lot of discussion not only this year, but next year in an election year, surrounding, are we spending too much? Are we spending too little? And what are we actually spending our money on? I'm not going to get into that. But I want to give you some facts as it relates to our debt and our deficit spending. You know, again, and people hate when I bring this up, but at the end of the day, right, when I think about the $32 trillion that we have in outstanding debt, since 1830 any of the excess spending that's not covered by tax receipts has been financed through our debt issuance, making sure that the interest expense component of that obligation on an annual basis was a very reasonable amount of fiscal spending. So let's talk about the facts. This year, the CBO is projected that our total deficit spending this year is going to be, or fiscal spending, I should say, is about $6.2 trillion. That's $1.3 trillion lower than last year's spending of $7.5 trillion. And when I look at the interest expense component, which when you think about what you covered, Phil, which was interest rates rising significantly, remember, 67 percent of our $32 trillion of debt outstanding is inside of 5 years. So think about that short end of the curve and how much rates have gone up. Right, so the CBO is projecting that this year total interest expense is only $640 billion, which is only 10 percent of total fiscal spending this year. It's still the smallest line item on our entire spending. So again, while that's up from 4% the previous year, if we believe that Treasury yields are going to fall, that would bode well for future interest expense as a component of fiscal expenditures. So again, I don't want to pretend that our debt is not too high and that we're not spending a lot, we are, but understand that it's not going to change any time in the future, and we're going to continue to finance that going forward, making sure that interest expense component is a much smaller component—or hopefully a much smaller component of our total fiscal expenditures. And by the way, the last part of that question is, bond market, as far as yields like Phil covered, we believe, forward expected returns for domestic bonds, good. So I think I covered it all, Amy.

Amy: You did great. Thank you. Phil, let's jump back to you and let Brent settle down a little bit. What is the real inflation outlook, considering that energy prices are again on the rise?

Phil: Yeah, so it's a good question. We've talked a lot about the inflation outlook, probably a bumpy ride lower. It's been pretty smooth, honestly. When you look at headline inflation, which does include energy, for 9 months now, but the likelihood that continues in a straight line is pretty low. Look, when you think about energy prices, it's interesting because they're the swing factor and there's something that the Fed really can't control. OPEC Plus has more impact on energy prices than the Fed does. So it is this unknown that they can be really frustrating. Now, what you see is that things like retail gas prices have swung higher recent months.

Brent: That's right.

Phil: By the way, I looked at this morning, down 11 percent from where they were a year ago. Right, crude oil has swung a bit higher recently, down 25 percent from where it was a year ago. It peaked last year at 122, what are we at, $76 right now. So we are well below, when you think about year-on-year inflation, we're well below where we were last year. That is good for the inflation area outlook. Look, energy prices, they tend to go up as things get warmer. Right, and you tend to have gas prices go up each summer. That is something that happens. And OPEC's not necessarily helping us in that stance, but it's very hard to dictate policy around OPEC Plus policy. My concern is, honestly, core inflation. And core inflation is frustrating because we all pay for food and energy, but really we want to see core inflation come down because again, energy prices do what they do. There's a war in Ukraine, crude oil skyrockets outside of our control. I want to see what core prices are doing. I did not like seeing that recent tick up and hopefully we do see a resumption, which when you think about things like owners' equivalent rent, we should, but we need to see it.

Brent: Oh yeah. Well, I mean, like, to your point, real yield's still sitting at positive 1.3 percent. So we went from an environment of TINA—here is no alternative—to TARA—there are reasonable alternatives. So when you think about it again, when we think about where volatility can play out, certainly you're going to have inflation volatility. Certainly you're going to have rate volatility. But ultimately, we believe the directional vector is lower for yields, lower for inflation. And at the end of the day, ultimately, depending on which moves faster than the other, I think real yields offer people choice in this environment, which lends itself to when you're thinking about portfolio construction, to have much more balance between stocks and bonds than you had in previous decades.

Amy: Phil, as you guessed, we've got a couple of questions on the budget and the debt ceiling stalemate happening. Do you see any adverse impacts on the economy and stock market moving forward?

Phil: Yeah so I think you have to split the economy and stock market here. When, when you, let's start with the stock market. One, we've sort of beaten, we have beaten this dead horse. But look, if it were to become really ugly brinksmanship, sort of 2011 style, you would expect that to impact risk assets negatively, and that, of course, includes the stock market. You'd expect if it follows the 2011 pattern, an actual rally in treasuries, which is a bit ironic because we're worried about Treasury credit quality, supposedly. Right, but you would see a flight to safety, a flight to the risk-free asset in treasuries. So that would be the impact there. Economic, it really, the question is, how long does that go on?

Brent: That's right.

Phil: Right, if this is something that is fairly short lived, say, 2011, the real impact to the economy would be very quick and transitory. If this becomes something that we don't expect, but the really drawn out, of course, it really starts to impact the economy because you're thinking about public spending, that percentage of GDP and the impact that has on consumer spending because of government workers, et cetera. So it could have an impact economic. The hope would be that if it does get ugly, it's pretty short lived. And this is more of a market story than an economic story.

Brent: Absolutely, and to your point, the political brinksmanship that's going to come in, both parties want to prove a point, but they're also not stupid. They understand that 2024 is an election year. And while you want to prove your point for each respective constituency, you need to make sure that you keep things somewhat stable. The last thing that you would want to do is introduce some type of, you know, economic cataclysmic type of event or some event in financial markets that distracts people from what you want them to do, which is choose a side and vote.

Phil: Right. That's right.

Amy: Phil, Brent, you may want to, there's another multifaceted one here that you may, may both want to weigh in on around the commercial real estate and whether we're expecting a meltdown there. And another question tying into that around, have we seen the bottom for stocks?

Phil: So I'll tackle commercial real estate. I think they maybe have something to say about that. And look, if you look at something like the Green Street commercial property index, it's down 15 percent year on year. So, so, look, commercial property, we're already seeing pricing decline. Very different than residential, where still low-price gains, but gains. Case-Shiller, I believe, was at 2 percent this week in the residential market. So, one, it already has started in commercial real estate. Now, where would it potentially be the ugliest? Well, you think urban office space, for example, suburban office space expected to be a little stronger. Right, so it's going to be very specific to where in commercial we're talking and honestly, what metro area you're talking about. Right, there is very different dynamics in commercial. Commercial tends to be lumpier than residential. It takes a long time to build a big office building or a big warehouse or a big retail complex. There's fewer of them. So, yes, there is reason to believe that commercial real estate is going to feel pain for some number of quarters. But the truth is, some of that's already in. And if we get asked about this continually, it is a bit of a known risk. Yes, an unknown risk at this point. But certainly something we're watching. And it's been a concern. It's been a concern when you look at the financial sector.

Brent: Oh, absolutely. And I think what's going to be interesting, there's a difference between when commercial real estate physically bottoms and when the marks start coming in. Remember, much of that is price, is not daily mark to market. So there's lags in pricing. So you're likely to see marks coming in on a lag quarterly basis that get worse and worse before you've actually passed the bottom. So we believe that we're going to hit a bottom in commercial real estate, but the marks are going to be coming in potentially a quarter or more after the end of the physical bottom of the commercial property index because of that lagged effect. To your point on the residential real estate, who knows? We might have been past the worst of it, knock on wood.

Phil: What was so interesting about residential is look, clearly the rate of sales fell, rate of housing starts fell as interest rates rose, but it's been such a limited supply. If you're locked in at a 2.6 percent mortgage rate, are you in a hurry to sell? So limited supply there has really helped to cushion the fall of residential.

Brent: I don't want to forget, Amy, the second part of your question is, you know, has the S&P 500 bottomed? We don't know. But in our opinion, we do believe that the October 12th low of 3,577 could in fact be the bottom, again relative to that historical analog, where, you know, the S&P 500 tends to bottom 6 to 9 months before earnings bottom. And if in fact, consensus is right, an EPS for this quarter does end up being the bottom in this cycle. You very well could have seen the bottom on October 12th, but time will certainly tell. I would say at least as it relates to forward PE multiples, next 12-month multiples, we are still trading a little bit rich. We are still almost 19 times, 18.6 times with a little bit of the market sell off for the last couple of days. That is a little bit above historical analogs as it relates to where next 12-month multiple should be an inflationary environment. Historically, that's really 17.4 to 17 times when you're kind of in that 2 to 4 percent inflation range. So we are trading a little expensive on a forward multiple basis. But again, I don't think that, I mean, that would imply more of 37, 3,800 than it would 3,577.

Amy: Thank you both. I've got one more here. Do you think we will ever get back to 2 percent inflation?

Phil: You want me to start? I'll start. So, one, my instinct, honestly, is not in the near term. Meaning the next couple of years, 18 months. One day, sure. One day, in one day, anything is possible. Two, look the Fed, I don't think they're changing their 2 percent target. Now remember, we ran well sub 2 percent for quite some time before the pandemic. I think a lot of the structural issues in the US, slower productivity growth, slower population growth, et cetera, persist. That actually should mean lower potential growth, lower potential inflation. The truth is, in my heart of hearts, if we ran it 2.5 percent, I'm totally fine with that if we're growing faster. Right, when you have low inflation, often that is indicative of slower economic growth. And that's the problem and the concern. So do I think we see 2 percent again? Yeah, I do. Do I think it's anytime in the very near term? No.

Brent: Yeah, well, let's just talk facts, Amy. Long-term inflation, 3.2 percent last 50 years, 2.7 percent. That's fact. Right, at the end of the day, all the points you brought up, completely valid. Let's also understand that when we think about, let's say, equity market returns or fixed-income market returns, people forget this. In the decade of the 80s, inflation annualized 5.6 percent. The S&P 500 did 17 percent per annum in bonds at 13 percent per annum. Let's hope that we see that. I don't think it's going to happen. Let's hope that actually does. So at the end of the day, I think it's about the growth story. And I think you're spot on with that. I think long term, you know, industrial advancements, technology, ultimately the technological advancement is long-term disinflationary from a tendency perspective. So maybe we'll get there. But I think we can certainly function anywhere north of, you know, two, 2.5 percent. I think that's completely fine.

Amy: Well, thank you both for answering all of those questions and sharing some deep insights and just really bringing everything together to it, for us today. If your question wasn't answered, just a reminder, reach out to your First Citizens partner and we'll get you that information over. Our next webinar is Wednesday, May 24th, at noon Eastern. And on behalf of all of us here at First Citizens, thank you for trusting us to bring you this information. That's something that we never take for granted here. And we hope to see you again next month. Thanks, Brent. Thanks, Phil.

Making Sense In Brief Outro Slide

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