Making Sense: 2024 Market & Economic Outlook

Amy: Hello, everyone. I'm Amy Thomas, a strategist here at First Citizens Bank. I'm joined today by Chief Investment Officer, Brent Ciliano, and Phil Neuhart, Director of Market and Economic Research. Today is Wednesday, December 13th, 2023. And I want to welcome you to our monthly Making Sense: Market Update series. This is our final discussion for 2023 and also our 2024 market outlook edition.

As always, the information you're about to hear are the views and opinions of only the authors at the time of recording and should be considered for educational purposes only. If you have any questions or concerns about your financial plan, please reach out to your First Citizens partner.

Brent, with that, we're ready to go, so I'll turn it over to you.

Brent: Excellent, Amy. Thank you so much, and good afternoon, everyone. Hope all of you are well. Well, Phil, another year has basically come and gone. What an incredible year 2023 has been. I think, Phil, if I can think of one word that would best describes this year, that word would be humility.

Phil: That's right. I mean, think about the things that humbled us and all investors this year—incredible rate volatility, an equity rally that exceeded expectations. Recession expectations coming into this year were very high. Of course, it did not come into fruition. The magnificent seven, of course, leading equity markets higher. Geopolitical risk—there's just been a lot, not to mention the Fed.

Brent: Yeah.

Phil: It really has been quite a year. So what are we going to cover in terms of today, Brent?

Brent: Yeah. I mean, so we—Phil and I, don't want to engage in wonton hubris and make some bold predictions coming into 2024. But we thought instead we're to focus on the top ten items that we think are going to drive the markets and the economy in 2024.

Phil: Right. So I'll handle the first half here. And all five of these items we have talked about ad nauseam this year. And I think they're really going to continue to be major topics next year. So first—inflation. You don't have 9.1% inflation last June, June of 2022, and that doesn't remain a topic.

The labor market's been incredibly resilient. We want to cover that. Monetary policy is—we had a Fed meeting this week—it really has been all about the Fed in terms of fixed-income and equity markets. We're going to cover that.

Commercial real estate—really a major risk factor out there. Something we're watching and market participants are as well.

Next year, you might have heard, is an election year. We'll want to touch on that. Something we'll be discussing, of course, throughout the year.

And then geopolitical risk, there is a lot out there. There's a lot of tragedy happening around the world. Something that's a major focus, and something we want to touch on.

Brent: Yeah, and when we think about what will matter, you know, corporate earnings and profitability coming out of the earnings recession that we had earlier this year. Where do earnings go from here? And certainly the starting point when we look at market valuations is critically important for future equity returns.

One of the items, Phil, that you and I get asked about all the time is "Hey, what is your price target for the next 12 months?" So we're going to get into our updated price target.

Clients always asking about "Hey, if we're heading towards a recession, what should I do? Should I stay in the market? Should I invest? What might the equity markets do?" We'll cover that.

A concept, Phil, that we talked about in our 2023 Outlook is this balance between stocks and bonds after the incredible markets that we saw for the decade ended 12/31 of 2021 and that divergence. What will the next decade look like? And then lastly, we pulled together some critical slides that, ultimately, you're going to want to rip out of this presentation, hang up on your wall and anytime you want to think about getting out of the markets or making an investment decision—you really need to refer to these slides before you make that decision.

Phil: Yeah, so let's jump right into inflation. If we flip to the first slide, Amy, a slide we've shown regularly, and we'll continue to show. We got fresh CPI data this week. As a reminder, I already mentioned it, inflation peaked at 9.1% in June of 2022. It has fallen most recently to 3.1%. As a reminder, the Fed's target—and you see this is the gold line—is 2%. We are still well above that. What you'll notice is—in terms of headline inflation—fell really sharply. And now we've kind of seen some volatility around 3 to 3.5%.

We're at currently at 3.1% but have certainly made progress and something that the market has cheered this year. One thing that we're focused on is core inflation, which is the gray line—that excludes food and energy. It's a measure of underlying inflation. That's still at 4%. It's above headline. It is double the Fed's 2% target and one of the reasons that the Fed is unlikely in our view to cut rates anytime soon.

We'll talk about that more in a moment. Clearly, a challenge still for the marketplace.

Brent: Absolutely.

Phil: So where might inflation go as we move forward? Well, this is consensus estimates. This is economists, dozens of economists across Wall Street. As you can see, inflation is expected in the gold bars here to continue to march lower to 2.4% at the end of next year.

What you'll notice is—one, you don't see any negative numbers here. We often get questions like "When are prices going to fall?" Well, select prices—things like airfares might fall, used car prices can be volatile, but broadly, it's very unlikely prices fall.

Brent: Yeah.

Phil: What we're cheering for and hoping for is lower inflation.

Brent: Yes.

Phil: But what you also don't see here is 2.0. If the Fed's target is 2.0%, we are not getting there next year. In terms of our view, we have disagreed with the consensus on inflation a lot. We actually think this is pretty reasonable—the idea that inflation continues to decline, but certainly does not fall below or to the Fed's target.

Another measure we've shown in the past and wanted to show here. We show this every couple quarters or so—on the next slide. It's something called supercore inflation. So if core inflation irritates you because it excludes food and energy.

Brent: You're super-sizing it.

Phil: Supercore is going to really irritate you. This is essentially core services less housing. So really trying to get to things the Fed is watching carefully, right? And trying to get to the underlying rate of inflation. And where we are today is certainly below where we were, but you can see from the dashed line—we're about 4% today in terms of supercore.

Brent: Way too high.

Phil: So still too high. Look at where that was—sort of the 2013 through the 2021 period. We still have work to do. So again, there's some euphoria around the Fed and the idea that the Fed's going to ease very quickly, but there is still inflation in the system, and we think they're going to have to take that seriously.

Brent: Yeah.

Phil: Something else we keep an eye on is owner's equivalent rent. Thank you, Amy. Owner's equivalent rent is about a quarter of the Consumer Price Index.

Brent: Yeah, a material component.

Phil: It is a measure. It's their attempt at measuring the cost of housing, right? It tends to track things like the Zillow rent index with a lag as you can see here. The gold line is owners equivalent rent, and Zillow is gray.

And it has tracked to an extent but has not fallen anywhere near the extent of the Zillow rent index, which by the way—that rent index is starting to flatten out.

Brent: Yes.

Phil: So the real question is do measures like the cost of housing—does the rate of inflation fall? I mean, it's still very positive. You can see on the left axis. Or is this a thing where home supply is so tight that we are not going to see the cost of housing improved to the extent that it really needs to get inflation lower?

Brent: Yeah, so rents are falling everywhere except in the official governmental data, and to your point—it's going to be interesting to see the path from here.

So if we shift gears, Amy, and we focus on the labor market. The labor market has been, Phil, a pillar of strength in this entire economic cycle, and as you can see, we've seen hundreds of thousands of jobs created.

If we look at the November data, you know, we saw—or the consensus expectations were for 185,000 jobs. Came in at a 199,000 jobs—exceeded expectation, which is good given that we saw a 150,000 in October. Nice to see that pick up and something that we're certainly going to watch.

But at the margin, Phil, we are starting to see the labor market slow. And if you can see that 6-month moving average, we've trended down from the 300,000s to 200,000s—now sitting at 186,000 jobs on a 6-month moving average. The labor market is starting to slow at the margin.

Phil: Absolutely.

Brent: On the next slide, what we've been following is unemployment. And we're looking at U-3 unemployment. We hit a secular low at 3.4% in April, Phil—lowest level in what, sixty years? And it's something that we're critically watching because it ticked up to the 3.9 in October and that was troublesome. Good news is—fell back to 3.7% here in November.

But I think for us, we want to continue to watch jobless claims and continuing claims to see if the labor market remains resilient or starts to continue to weaken at the margin.

Phil: And one thing I'd add, Brent, is participation improved in the most recent report. We want to see participation strong. If that starts to decline, it might mean there's discouraged workers, right?

Brent: For sure.

Phil: So something else just to keep an eye on.

Brent: Yeah, and on the next slide—ultimately, the most important thing, Phil, is consumers, right? Because the consumer explains 72% of US real GDP. 68% is consumption, another 4% is housing. So as goes the consumer as, ultimately, goes the economy.

Gold line here is spending on goods. Gray line is spending on services. And you can see, as we've said many times in our Webexes, moderating from the significant highs that we saw back in 2021. If we focus on goods spending—not only moderating lower, but we are now materially below the long-term average in spending for goods. This holiday season has been just okay. Time will tell when we get the official final data in.

The good news is, Phil, on services spending—clocking in at 6.8%—is 1.5 times the long-term average. And when I disaggregate total consumption—more than 75% of total consumption is spending on services. So it's good to see that spending on services is clocking in at a reasonably high rate relative to the long-term average, which, for us leads us to believe that maybe the moderation lower year over year in real GDP won't be as extreme as to what's been priced into market or consensus expectations.

Phil: Right. Certainly, the labor market and consumer have kept us afloat as other parts of the economy have slowed.

Let's turn to monetary policy, which really is having an impact on everything we're discussing. Higher rates impact the economy more broadly and impact asset classes. Here we are showing the path of various Fed tightening cycles. The gold bar is the cycle we're in. It began March of last year. As you'll see, going all the way back to 1983, it is the outlier in terms of aggression.

So for most people in their working lives this is most sharp increase from beginning to end that we have seen. Now the Fed has been on hold since their hike over the summer. And this week, of course, decided to hold again and admitted in their statement including the word "any" that potentially that is it for them. So you can see the December economic projection is just a flat line. They are now projecting, what 75 basis points of cuts next year?

Brent: That's right.

Phil: If you look at Fed funds futures, which really, what the futures market is pricing, they don't necessarily believe the Fed. And they rarely do, by the way. Right now, futures are pricing roughly a 60% chance that the first cut is in March, right? Not that long ago, futures were pricing June. So that has really been pulled forward. Also, they're pricing five or six cuts—25 basis point cuts—next year.

Brent: Crazy.

Phil: Much more than was expected even a few weeks ago. Now, look, our view is we think it's pretty unlikely the Fed's cutting as soon as the first quarter. We still have elevated core inflation, and we think the Fed is okay to remain on hold. Now if something breaks from a macroeconomic perspective, of course, that'll be data dependent.

In addition, when you look at that five or six cuts—we'll take the under on that. While they may be cutting next year, we do not see that they get to five or six outside the macro environment deteriorating.

So let's turn ahead to another measure of the Fed funds rate. This is a proxy effective Fed funds rate, which sounds—

Brent: Sounds complicated.

Phil: It sounds very fancy. It's actually a measure from the Fed. It's not that fancy. All it does is it's looking at not just the Fed funds rate, but also things like the Fed balance sheet. So if you look back early in this chart—sort of the 2010 after the great financial crisis all the way until what, 2015? The proxy effective funds rate was actually negative.

Brent: Quantitative easing.

Phil: We had massive quantitative easing, right, and massive dovish guidance from the Fed. So the truth is while the Fed funds rate was in the zero to quarter-point range, the proxy was negative. What you see now is the inverse of that. The proxy effective funds rate is actually above the Fed funds rate. In other words, financial conditions are tighter than the Fed funds rate would imply. Something to consider. And it's been that way really since well before the Fed started hiking early last year.

So why is that? Well, we have quantitative tightening, the Fed is shrinking its balance sheet, and they have hiked so aggressively that you're seeing the pendulum swing the other way.

Brent: So let's talk about equity markets and monetary policy and the intersection of those two. What we're looking at here is 6 months post either the Fed holding monetary policy flat or beginning to cut rates.

The gold line is six—is the S&P 500's movement. And again, based at 100 what we look like 6 months post the Fed holding. And you can see in that gold line—if the Fed has held rates steady, that's usually been good for equity markets. And we've seen roughly 9 to 10% move on average once the Fed holds rates steady.

On the other side of that equation, if the Fed cut rates at the end of a cycle, it resulted in the equity markets basically trading down a little bit but then ultimately flat—which makes sense, Phil, when you think about "Why would the Fed be cutting rates?" It's in response to weakening economic conditions and the potential for a recession. And hence you would expect the equity markets to potentially move lower or at least sideways if, in fact, you saw worsening economic conditions.

Phil: That's right. Usually, the Fed is cutting because there's deterioration of fundamentals. So in some ways investors should be careful what they wish for. Fed cutting is not necessarily bullish for stocks because sometimes something— often, usually—something broke, and that is why they are cutting rates. The Fed's walking a tightrope. They're trying, you know, balancing rates trying to cut, trying to make goldilocks happen, and that tight rope certainly continues.

So let's switch gears to commercial real estate. As we flip ahead, Amy, this is something we've highlighted now for much of this year, and it remains a risk. Commercial real estate property values on the left side. This is year-to-year change. Still negative, negative something like 10% year on year as of November. If you look from the peak of values—all property, all commercial real estate down 22% from the peak.

Brent: Wow.

Phil: Office, as we all know, sort of been the tip of the spear—down 35%, particularly in urban office. And you can see apartment, industrial and strip retail. The one caveat we always are sure to mention is—one, with commercial real estate it really depends where you are, right? Your locale matters. And what type of real estate. You know, urban office and suburban office may look different. Apartment may look very different in your locale. But this is a challenge and something that certainly we think markets are going to be facing in 2024. And likely that this story could lead into 2025 as well.

Brent: Oh, absolutely.

Phil: This is an illiquid market. It takes time to watch this play out, something that we're going to be watching as we enter the new year. As we flip ahead, Amy, the other thing we're keeping a watch on is that small banks are more exposed to commercial real estate.

Brent: Yes they are.

Phil: So if this is a risk and you are looking at banks' total assets—which we are here—if you look at their percentage of their assets that are CRE loans, commercial real estate loans. If you look at smaller banks, the dashed line here is $1 to $10 billion dollar banks by assets—nearly 35% of their assets, their total assets, are CRE, commercial real estate. As you get to bigger banks—$10 to $250 billion, one—and north of $250 billion, the gray and gold bars here. It is smaller. So this is certainly something that we think is going to take time to play out but is a risk factor in terms of financial markets.

Brent: Yeah, and small banks—so think banks, Phil, outside of the top 25—hold 70% of CRE bank loans—70%. Just an enormous amount. Additionally, you have $1.5 trillion dollars of CRE bank loans that need to be refinanced between today and the end of 2025 against the backdrop of potentially higher rates.

So that could potentially put strain on small- to medium-sized banks and their balance sheets and switching from a lender to potentially a landlord, which would create problems not only for banks but problems in the commercial real estate market as those already illiquid properties become even more illiquid when you have a fire sale potential.

So let's talk about a presidential election year and geopolitical events. Phil, did you know that 2024 is a presidential election year?

Phil: Big news to me.

Brent: I know how much you love talking about presidential elections.

Phil: I can't wait.

Brent: Can't wait. So what we're looking at here is the presidential cycle and performance of the S&P 500. The gold bars are for the incumbent president, and the gray bars are for newly elected presidents. And, obviously, Joe Biden was a newly elected president. The year 2024 would be the fourth year of this presidential cycle.

Historically, in the fourth year of presidential cycles for a newly elected president, equity markets have done well—on average about 12% returns. But by and large, Phil, we have so many people commenting on whether this is good, bad, ugly, indifferent. Since 1877, the average return for the equity markets for a Republican president has been 9%. The average return for a Democratic president has been 11%. So whether it's a Republican president or Democratic president, equity markets historically have been relatively strong.

So we need to focus more on the economic side, the valuation side, and less about who's in office. I know that's hard to do in a presidential election year. You know, emotions and tensions run high, but certainly something to keep in mind.

Phil: Yeah, go back to fundamentals.

Brent: Yes, back to fundamentals. So the geopolitical side. Certainly the war in Ukraine and the war between Hamas and Israel is absolutely and unequivocally a human travesty, and I think both Phil and I are hoping for a speedy resolution to that conflict. But what we think about when it relates to equity markets—we're looking at almost every major geopolitical event, Phil, since World War II. By and large, what has the impact been on equity markets?

And if you look down at the bottom of this graph, on average, geopolitical events have demonstrated a modest negative effect on equity markets—mid-single digits both average and median. But when you look 1 month, 3 months, 6 months, 12 months post those events, on average equity markets have recovered. And broadly geopolitical events are technically—or at least historically been—nonevents for equity markets over history. So again, when we're looking at these most recent conflicts it's been a similar story.

Phil: That's right. I mean, every year of our careers we've been asked about geopolitical risks because sadly there always is. There's always wars. There's always tragedies. Hurricanes, I mean, things that are not just driven by humans. But usually, the markets do turn back to fundamentals more quickly than many might think.

Speaking of fundamentals, let's talk corporate earnings and market valuation. So starting with earnings. If you look 2023 earnings growth—we don't have fourth quarter yet—these are still estimates, but something like 0.7% growth.

Brent: Flattish.

Phil: So basically a flat earnings growth here. So when you think about markets. Well, 2022 we had a pretty severe drawdown. The market was looking ahead to a not-so-great earnings picture for 2023—obviously well-below average. And now we're rallying, looking ahead to what's expected to be 11.8% on this growth next year. Now, we think that's probably a bit optimistic, 11.8%. But nonetheless, the idea that earnings bounce back from a down year this year certainly is a reason for optimism.

Another reason for optimism is the right side. This is a 12-month forward operating margin. So when you think about fundamentals, you know, margin is one of the most important things to think about with S&P 500 companies. And after falling from sort of the easy money post pandemic, you can see that we are now swinging higher in terms of operating margin. And that is a really good thing when you think about forward earnings.

Brent: Yeah, and you think about it—even if, you know, even if analysts sharpen their pencil lower from 11.8% relative to the long-term average of 7.6%, somewhere between average [inaudible] currently expecting. Again, markets are expectational pricing mechanisms and maybe have bid themselves up in anticipation of this recovery in earnings as we head into 2024 and beyond.

Phil: That's right. So let's move to valuation. And when you hear the word valuation, it's a fancy market term for things like the price-to-earnings ratio as we flip ahead, Amy. So here we're showing next 12 month price-to-earnings. Well, what is that? So looking ahead over the next year, what is the price the market is willing to pay for a dollar of earnings? So higher means more expensive, lower means cheaper.

We're showing long-term price-to-earnings here all the way back to 1985. You can see where we are today, depending by which measure, you know, 18.5 to 19 times is certainly well above average—but also quite a bit below the highs we saw in 2021 et cetera. The other thing we'd like to point out here is rarely does the market trade at the average.

Brent: Yeah.

Phil: So again, much like geopolitical, every year you hear the market is below average or above average on valuation. Well, that's not really a very good short-term indicator. In fact, the market could stay below average as you could see in the 80s for a long period of time. It could stay above average as you could see in the 90s for a very long period of time. The truth is—what are the fundamentals?

Multiple is very hard to predict, but certainly you could not say that the market is trading cheaply today. It is a fairly expensive market thanks to the big rally we've had this year.

Brent: Well, yeah. And again, it is interesting to see that a plus 20% rally year to date, and we are not significantly expensive on a forward PE ratio. It's kind of good to see. You know, we're not cheap by any measure, but we're certainly not expensive either.

Phil: Exactly, exactly.

Brent: So another valuation metric—and I think we covered this in the 2023 Outlook—is something called the Shiller CAPE ratio or Cyclically Adjusted PE ratio, which sounds really complicated. It's nothing more than the price of the S&P 500 divided by the average 10-year earnings for the S&P 500 adjusted for inflation.

You can see back in June of 2021, we hit the second highest peak reading in more than 100 years. And we've been falling ever since then as it relates to that valuation metric. And while the Shiller CAPE ratio, Phil, is a very bad predictor of shorter-term performance, on the next slide, Amy, you can see that it's been pretty darn accurate when you look at a full decade ahead. And we're looking at here on the vertical axis is 10-year annualized real return—post those readings for the S&P 500. Horizontal axis is CAPE ratio low to high.

And what you can see is the higher the starting point from a valuation—so the higher the CAPE ratio—the historically lower the 10-year forward real return is for the S&P.

Phil: 1999 is an obvious example, the peak of the tech bubble.

Brent: Exactly, 2001. Yeah, what you saw on that big peak run-up. Again, it ran up continually over the shorter term. But longer term over that full market cycle, you end up with an equity market that was lower. So valuations as a starting point is very, very critical in making investment decisions.

Phil: And the good news, the bad news is it was very expensive, say, 2 years ago.

Brent: That's right.

Phil: Looks better today.

Brent: Exactly.

Phil: So to the point of "What are our views in terms of the stock market?" Let's talk about our S&P 500 price target. As you can see here, we're adjusting our 12-month forward price target—we usually do this once a quarter—to 4,850 on our base case. That's up about 5% from the 11th. Market is trading pretty actively this week so.

Brent: We might get through that by the end of this call.

Phil: Yeah, we shall see. But this is based on fundamentals, and we have our bear case and our bull case. Bear case down about 20%. Bull case up about 19%. So let's just go—we won't do this every call—but when we make adjustments, we like to discuss some of what we're watching.

So in the bear case, that is looking at downward next 12-month earnings. So next year, downward revision to the expectations followed by below-average earnings growth in the following year and multiple—which we talk about that price-to-earnings—contraction. So in other words, earnings miss and you see a cheaper market. That's how you get to the bear case.

The base case is modest downward revision. We're being conservative to next 12 months. Followed by average earnings growth in the following year with slight, very slight multiple contraction, basically flat multiple. That's how you get to 5%.

Then the bull case. If you're more optimistic—I describe our base case as cautiously optimistic—if you're go go right now, the bull case, that's positive earnings revisions followed by slightly above average earnings in the following year with multiple expansion. So that is going back to something like 20 times or more multiple—that is how you get to the bull case.

Brent: Yeah, and you don't see up here that 3,577 that we hit back on October 12th of 2022. So again, we'll have to see what the earnings montage looks like, but ultimately, 4,850 is a pretty reasonable expectation.

Phil: Well, and the other thing is—remember this is in the context of a market that has been running upward very hard, not just all year, but even in recent weeks. So 5% on top of that would still be a pretty great 2-year return.

Brent: Absolutely. So let's talk about markets and equity markets in recessionary periods and something that you and I get asked about all the time. And we highlighted this not only in previous Webexes, we actually put out a note on that. It's available on the website. What we're looking at here is the last 12 recessions post World War 2. And what you can see is on average, Phil, recessions lasted about 10 months. And when you think about what the S&P 500 did during those recessions, half the time you got a positive result. The other half the time you got a negative result.

Big skew, though, right? When the markets were positive, you saw a pretty significant double-digit return about 15 to 16% average median. When we saw the negative events, on average mid-single digits, but really when you look at the median observation—basically flat.

But what you and I would say is that most of our clients are investing beyond 10 months and are thinking about their long-term plan and investing for the intermediate-to-longer term. What we really want you to focus on is, "What has the S&P 500's performance been post recessionary periods?"

And when you look at the chart—1, 3, 5 and 10 years—we've seen significantly positive results. 92% of observations, 1 year post recession—the market's been positive. 3, 5 and 10 years post recession—the market's been positive 100% of observations. And when you look at that average and median cumulative return in the 3, 5 and 10—very, very tight. So you don't have any skew. You don't have any handful of periods that are really distorting. It's been a pretty consistent positive result post-recessionary periods, which we think is really important.

Phil: Something that always amazes me about this table is that, as you mentioned, during recession—the actual recession dates—you can have a positive market.

Brent: Absolutely.

Phil: Why is that? Markets are not always very good forward looking, but often are pretty good forward looking. They priced the recession before it actually occurred. So that's where the split between markets and the economy is real.

Brent: Yes.

Phil: They don't necessarily move exactly in tandem. Markets are trying to price forward activity.

Brent: Absolutely. So let's talk about asset allocation. And again, this is a concept that you and I hit last year. But thinking about the balance between stocks and bonds in a portfolio, we think is going to be critically important, not just for 2024—but for the next decade.

What we're looking at here is the 10-year rolling return on the S&P 500 going back 100 years, Phil. And you can see a lot of variability in that 10-year rolling return. I think what's interesting is—look at that gray line at the bottom. Look at the percentage of observations or the number of observations that are above zero. More often than not, investing over the long term, 10-year rolling returns have equated in a positive nominal experience. Very infrequently do we have a negative nominal return when you had a 10-year holding period.

So if we go to the next slide, Amy, we think about where we've come from and where we might be going. As you and I talked about, the decade ended 12/31 of 2021 was extraordinary. We had unprecedented monetary and fiscal policy stimulus—an excess of 10 trillion dollars. We had interest rates, Phil, at zero for upwards of 8 years—really drove risk assets. Stocks returned 16.3% per year for an entire decade—60% above that long-term average that I showed you. Just incredible returns.

At the same time, bonds returned only 2.9%. So the spread between stocks and bonds was in the top quartile of widest spreads that we've seen in more than 75 years. So where you were on that efficient frontier, the more you add in stocks, the better your returns were at a portfolio level.

What we care about now is looking forward. That next 10 years is looking at the Horizon Actuary Study, which looks at 42 of the biggest firms and their expectations for stocks and bonds over the next decade. On average, companies that are forecasting believe that US stocks will return about 7% per year over the next decade. And again, it's never linear. You're not going to expect to see 7% per year. High highs and low lows get you that average, but 7% is still a good number, Phil. But as we just showed you—pretty materially below the long-term average of 10.5%.

What's interesting is that bonds are expected to do 4.7%, which is significantly better than what we saw with the decade ended. So that spread between stocks and bonds, if this were to hold true, would be in the lowest quartile of spreads between stocks and bonds in the last 75 years.

So where you are on the efficient frontier is critically important if this were to hold true, capturing almost 2/3 of the returns of stocks with only about 30% of the risk. So we believe not only next year but the next decade is going to be about financial planning—about having balance in your portfolio and diversified assets and balance between stocks and bonds.

Phil: And to that point, fixed income is suddenly a more attractive asset class than what we saw prior to the increase in rates—in the image that 4.7%. Well, looking here, it kind of rhymes with yield to worst.

So here we're showing the yield to worst of various fixed-income asset classes at early 2022—end of 2021—and where we were, what was that? Last Friday on December 8th. And you'll notice even with the recent quick decline in interest rates, you're still in a very different place. The 10-year was at 1.5%, 4.2 as of Friday. The aggregate bond 1.75%, now almost 5%. It really jumps off the page.

So even with interest rates falling in recent weeks, it's still far more attractive. And again, that balance between stocks and bonds—suddenly fixed income is an asset class that's viable that wasn't necessarily viable to institutions and individuals alike.

So why do we focus on yield to worst, as we flip ahead, is that it is usually a pretty good indicator of forward return. So here we're showing for the aggregate bond index—what is the percent capture of yield to worse. So what do we mean by that? Let's say in a given year, aggregate bond is yielding 5% in the duration 6 years, right? So 6 years, 5%. Over those 6 years, how much of that 5% did it capture in total return? Well, on average going all the way back to the late 80s, it's 111%. In other words, you capture a little bit more of that yield to worst.

Now the exception has been recent years. You see those low bars on the right side. Why is that? You had an historic move from record low rates up very quickly—yields go up, price goes down.

So really recent years has been the exception. Look historically—usually, when you buy the aggregate bond index, you can expect over that duration period pretty good capture of the yield to worst.

Brent: Yeah. So let's bring this home, Phil. And Phil and I want to highlight for you four slides that I honestly believe, Phil, people should rip out of this presentation deck and hang in their office, their wall, wherever they're making investment decisions to remind themselves to stay invested, right? So what we're looking at here is timing—getting into the market, getting out of the market.

What we're looking at here is investing $10,000 over a 30-year period of 1992 through 2021. Investing $10,000 over those 30 years grew to $208,000, Phil—to almost 21 x your initial investment. Truly incredible. On average, Phil, there's about 250 trading days in the year. So we're talking about roughly 7,500 trading days in this example. Let's look at that second bar. If you missed the 10 best trading days out of 7,500 you ended up with less than half of that money. That is staggering.

And if you go to that bar after that. If you, god forbid, miss the best 20 days out of the 7,500 trading days in this example—you had almost three quarters less money. So that's just staggering data. What's really important for investors is what's written in that box. 48% of the S&P 500's best days, Phil, occurred during a bear market. Another 28% occurred in the first 2 months of a bull market when nobody knew it was a bull market.

So a full 76% of the S&P 500's best trading days occurred when you'd never want to be an investor. So not only is it insanely hard to time when to get out and conversely back in—missing the best days can cost you significant accretion of wealth over time.

So let's move beyond timing when to get in and out of markets, Phil. This is probably a more reasonable question that we get from clients is, "Hey Phil, Brent, I'm sitting on cash now. Money market funds, bank deposits have been high. When do I get back in?"

So what we're looking at, and we did research on investing $12,000 per year over a 40-year period—1980 to 2023—and when you put your money in. So the first bar is if I put $12,000 into the market every year for 40 years, and I had divine intervention, perfect timing, and I could put that $12,000 in each year at the S&P 500 low. Your money grew from $12,000 per year for 40 years all the way to $10.5 million dollars. Don't you and I wish that we had that perfect foresight to be able to do that?

Phil: Yeah.

Brent: What is interesting is really the bars to the right. If you had the worst timing, which sometimes when we talk to clients, they think that they have the worst timing.

Phil: It feels like it sometimes doesn't it?

Brent: Yeah. That's what they're fearing. If you, god forbid, put your $12,000 in each year for 40 years at exactly the S&P 500's high, you still captured 76% of that perfect timing.

What I think is the most interesting bar is the third bar, which I actually had to go back and double check—and our team did a great job on this. If you put your money in that $12,000 in each year for 40 years on the first trading day of the year you captured 92% of perfect timing—92%, Phil.

And then when you look at the last bar, which is a disciplined investment program where you're putting that $1,000 in each month, $12,000 for the year, each month—you captured 87% of perfect timing.

The gray bar is what you need to be fearful of. You overthink this. You don't put your money in. You worry about whether I'm getting in too high, too low, not at all. That will result in significant decrease in the accumulation of your wealth over time. So it doesn't really matter, Phil, whether you're worst timing, first day of the year or a monthly dollar cost averaging—you're still capturing a significant amount of perfect timing.

Phil: That's right, and so we flip ahead. Let's look at drawdowns, right? So this is S&P 500, 10% or greater drawdowns going back to World War 2. One, you'll notice that pretty material drawdowns are pretty common, right? That's why equities are a long-term asset. You have to be ready for potential drawdowns.

Another thing I want to point out is the top row. That is the current cycle, right? We hit an all time on January 3rd of 2022. We are now—if you look at the far right column—this is the month's peak-to-full recovery. How long did you—till you got your money back in total return terms. In total return terms, we're within 1%.

We might actually, as we're recording this, be hitting that total return. But you are right there. So let's call it almost 2 years. On median, the bottom here, it's usually about 12 months—on average about 17 months. What you'll notice, though, is none of these periods were permanent, right? The truth is the market, it may take a while, right—think about the tech bubble, think about the great financial crisis—but eventually investors do earn their money back and hopefully their dollar cost average, again, as we mentioned on the last table.

So what really permanently impairs assets is us doing what humans do, which is behaviorally reacting and taking to realize loss and not holding assets for the long term. It is about the financial plan, right? It's about having your assets in the right buckets, right? Equities are long-term assets, for example. But it's about sticking to that plan that really pays off as you were discussing.

So let's show this one more way, Brent, on the final slide. So since 1970, if you were in the market—a growth of $10,000 has grown to over $2 million, which is pretty incredible. You can see on the right side the little peak that was the all-time high beginning of 2022. Of course, in the context of decades of investing—that's just a bump, right? That is nothing compared to what we have seen in the past.

But what we're showing here is that there's always a wall of worry. There is always geopolitical risk. There's always things we're concerned about, but the truth is not reacting emotionally and really investing for the long term—those long-term assets—does pay off in the long term.

Brent: Yeah, that's exactly right. So Phil and I want to thank you so much for your time, your attention. We've done a lot of Webexes. We've done a lot of talking this year. Phil and I wish you all the best this holiday season, and we wish you well in the new year, and we hope you join us again in 2024.

Amy: Thank you, Brent. Thank you, Phil, for all that information. And before we wrap things up, just a reminder to all those who are interested we offer to our subscribers several publications throughout the month. That includes Phil's weekly economic update in our In Brief series that comes out every single Monday morning, along with various and sundry commentaries throughout the month. If you are not already a subscriber, you can hit the QR code and get signed up there.

Also, I want to invite you to take a look at our new market outlook page. If you are like me and maybe need a break from all of the holiday festivities over the next few weeks, maybe go visit firstcitizens.com and take a look at some of our commentaries and videos and start planning the year for 2024.

Brent, Phil, thank you both so much for sharing all of your thoughts throughout the year and keeping everyone informed. I know a lot goes into it, and a lot of your time is invested that way. Just want, and to everyone listening in today—on behalf of all of us here at First Citizens, I just want to thank you for trusting us to bring you this information. That's something that we never take for granted. We want to wish you and those closest to you a safe and happy holiday season, and we will see you back here in January of 2024.

Making Sense Outro Slide

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