Market Outlook · January 30, 2023

Making Sense: January Highlights

Brent Ciliano

CFA | SVP, Chief Investment Officer

Phillip Neuhart

SVP, Director of Market and Economic Research

Making Sense: January highlights webinar replay

Amy: Hello, everyone and welcome to the First Citizens Wealth Management webinar series, Making Sense, where Chief Investment Officer Brent Ciliano and Director of Market and Economic Research Phil Neuhart, help you make sense of what's going on in both the markets and the economy. I'm Amy Thomas, a strategist with First Citizens Bank. Before we get started, I do have a couple of housekeeping items to get through. First, today's webinar is being recorded, and a replay will automatically be sent to you following today's conference. Secondly, this webinar is interactive. If you'd like to ask a question, please use the Q&A or the chat feature on the righthand 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 broad, so if you have a specific question about your financial plan or we're not able to answer your question on 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, with that, we're ready to go, so I'll turn it over to you.

Brent: Great, well thank you, Amy. And good afternoon, everybody. I hope all of you had a nice and relaxing holiday break. Well, Phil—2023, the start of another year, and we get to do it all over again.

Phil: That's right.

Brent: I think we're both hoping that 2023 turns out to be a better year than what 2022 was. So what are Phil and I going to cover today? We're going to hit some key economic factors that we think are going to affect the underlying sequencing of events this year. It certainly will be important all year, but for the beginning. Then we're going to hit some highlights on 2022: equity markets, fixed income markets, what transpired and what to expect this year. Then, Phil, we covered five views—

Phil: Right.

Brent: —in our outlook. We're going to hit three that we think are most important for the first half of this year, certainly important for the full year, but important for the sequencing of what's going to happen. So why don't we jump right in, Amy?

So Phil and I covered global growth and the global growth outlook in our 2023 outlook. What we're going to be focusing on today, folks, is just US real GDP. And what you can see on the lefthand side is expectations for growth in 2022. GDP comes out tomorrow, so we'll have a better lens on that. Growth expectations for 2% for last year. This year, Phil, half a percent. Significant downward movement in growth expectation.

Phil: And our recession probability is still 60%, so odds on, not a slam dunk. If you look at the quarterly data, lots of volatility there.

Brent: Yeah.

Phil: With tomorrow's report, we're going to get more detail and you'll start to see revisions, of course, to the forward quarters. But it's going to be a choppy year economically. And when you see that slower growth as we flip ahead, that impacts inflation.

Brent: That's right.

Phil: So inflation peaked last June at 9.1%. It has fallen, and here we're showing headline consumer price index in the gold line. It has fallen each month since last June. Most recently, 6.5% in December. Still far too high.

Brent: Yep.

Phil: The Fed's target is 2%. It's three times that. But when you think about the market rallying thus far this year, some of that is that inflation has been trending lower and the market is cheering that.

Brent: And the velocity of inflation moderation is starting to pick up too. So it's not only the directional factor, but the magnitude as well.

Phil: That's right. So it took a lot longer than any of us wanted, but we are starting to see that inflation is tarting to come down. That is starting to impact expectations, as we can see on this slide. Consensus estimates her, by quarter, are the gold bars looking forward. What we have seen through much of last year was each time we refresh this data, each month, the consensus went higher.

Brent: That's right.

Phil: So the black diamonds are where we were in March of 2022 going higher. What's interesting is this month, the numbers fell.

Brent: That's right.

Phil: So as a point of comparison, that first quarter, 2023 at 5.8%, in December, when we ran this data, it was 6.2%. So proportionately pretty decent declines. So what's happening is consensus was fighting to catch up with sky-high inflation. Now they're fighting to catch up on the downside. So it's good to see downward revisions finally in inflation data.

Brent: And when you go back a couple of quarters to expect that the end of this year are consensus expectations sitting at 3%, we'd all be cheering for that. So let's knock on wood and hope that actually comes to fruition.

Phil: That's right. And some reasons that might happen are shown on the next slide. One, we aren't sure we hear but at least acknowledge it's supply chains. Supply chains, still some real disruptions, but we have seen improvement from where we were a year ago. Another key component in the consumer price index is called owners' equivalent rent. It's a controversial measure of it. A lot of economists tend not to like it the way it's measured, but it is 25% almost of the index—24%, to be exact. And what you've seen in this owners' equivalent rent, the gold line here, is that it continues to rise. Now, what's interesting is we all know through various price indexes that home price moderation is occurring. Right we're seeing declines in the rate of appreciation.

Brent: Case-Shiller.

Phil: Case-Shiller. Here we're showing a Zillow rent index and we're doing a nine-month lead on it tends to lead owners' equivalent rent. You see, it's fallen pretty sharply from pushing 18% to 8%. So we do believe that there's some downward pressure to CPI from measures like owners' equivalent rent.

Brent: Yeah, it's just not showing up in the official Fed data, but the real economy is absolutely showing signs.

Phil: That's right. So, and again, as we were saying, when inflation was high—be careful what you wish for. Right, the economy slowing. The Fed's been aggressive. That does push down inflation. So speaking of the Fed, as we flip ahead, what are we showing here? So here we're showing the Fed funds rate, the overnight rate, which you hear reported in the press in the gold bars versus the consumer price index, inflation in the gray bars. And each date here is the end of a Fed-tightening cycle. And what you'll notice as you look at all of these bars, that the Fed funds rate exceeds the rate of inflation before the Fed stops hiking. That is not yet the case in the US. On the right side, we have the Fed funds rate, the top end of their range at 4.5%, and we have CPI at 6.5% as of December.

Brent: Right.

Phil: Now, you need that gold bar to go above the gray bar. There is reason to think that that happens probably in the first half of this year as the Fed continues to hike. So, so let's talk about Fed policy. The February 1 meeting, consensus has, you know, with very high probability, the, and I should say futures, not consensus, futures have it hiking 0.25%.

Brent: Right.

Phil: Likely, if you believe futures, hiking another 0.25% this year. What's interesting is there is a difference between what the Fed is saying, if we flip back one, Amy, between what the Fed is saying and what futures are saying. So the Fed, in their own forecasts, is saying, we're going to be north of 5% at the end of this year.

Brent: Right.

Phil: Well, actually, the 5% to five-and-a-quarter range. Futures are saying they're never going to get to 5%.

Brent: Right, and then come back down the other side.

Phil: And then futures think they're going to cut the back half of the year.

Brent: That's right.

Phil:Our instinct is that the Fed is going to be data dependent. So they're going to be hesitant to cut rates. So they're going to hike. We think that they likely want to hold rates at an elevated level for some amount of time. That said—

Brent: Yeah.

Phil:—we could have real downturn in the economy and the Fed cuts. But there is a real difference right now between what markets are pricing and the Fed.

Brent: And to your point, we've never seen a point where that in that crossover, where Fed fought where inflation was above Fed funds when that cycle ended. So I think that's the real key takeaway. It's just going to take some time for the data to come through—

Phil:Before we see that we've made progress. But we have a ways to go. So what about the fiscal side, Brent?

Brent: Yeah so as you mentioned, right, so monetary policy has, you know, created tighter financial conditions. But Phil, so, so has fiscal policy tightening. We talked about in our last handful of WebExes, the incredible explosion in M2 money supply and money growth. When we look at this graph, what we're looking at is federal spending as a percent of GDP. And you can see the significant comedown in fiscal spending and in federal spending. But when you look at that dotted line, we are still materially above the long-term average of federal spending as a percent of GDP. So we definitely have a long way to go. But fiscal policy is very, very tight and likely to get tighter. We've had M2 money supply year over year, seasonally adjusted for the first time ever actually go negative. Right, so there's a lot of headwinds from fiscal policy. We've had the debt ceiling debate rage. We've had a number of questions before this WebEx ask about the debt ceiling. We're in a situation where we hit $31.4 trillion, right, we officially hit that on January 19. The Treasury is taking extreme measures to be able to fund current obligations. They have money through at least the early part of June, but that's going to be a hotly debated topic in government to extend that debt ceiling limit. And they've done so for decades, and decades and we believe that that's going to continue.

So another thing that we think is very, very important to keep an eye on is that the labor market, Phil continues to be tight. Right, the JOLTS data, which is still at ten-and-a-half million open jobs. And what we're looking at here is the number of job openings per unemployed person.

Phil: Right.

Brent: 1.75 open jobs per unemployed person. We still have a very, very tight labor market. The unemployment rate is 3.5%. The 50-year average unemployment rate is 6.2. Right, we are at a 50-year low, adding 223,000 jobs in December versus consensus expectations of 175. 307 on a 6-month moving average. The labor market, despite what you hear in the news media and the financial news media about job cuts, which are starting—but at the end of the day, the labor market is still very buoyant and very tight at the same time.

Phil: And that's something that is supporting consumer spending. When you think about this economy, what was really the one bright spot was the consumer is still spending. Now, what we should acknowledge is if you look at retail sales data, use of consumer credit, savings rate declining, you are starting to see some softening. Inflation's starting to take its toll. But in the end, if the job market is tight, that does provide some sort of floor on consumer consumption.

Brent: Absolutely. Another very important key data factor that we think is going to affect not only the economy and markets over the next several quarters is corporate earnings and profitability, right? Phil, we're in the middle of earnings season right now. About 100 S&P 500 companies have reported, so about 20% there. Big picture, 70% are beating on the bottom line. Much, much lower expectations.

Phil: A lowered bar.

Brent: They're stepping over that bar where you had 75% of companies beating on the bottom line in the previous quarter. Consensus expectations for the fourth quarter, looking to contract, right? It would be the first quarterly contraction since the third quarter of 2020. Big-picture expectations for all of fiscal 2022, still modestly positive, $220 per share. I think looking at 2023, consensus expectations continues to fall, Phil, but we're still looking at modest single-digit growth at about $228 per share. But when you look at the graph on the right and we look at operating margins, we peaked out in 2021 at almost 17.6%, which was like the highest that we've seen in decades. We're moderating lower, but we're still at a high rate. And I think this is sort of that crossover between corporate earnings and profitability, what's good for the consumer and the economy as inflation continues to moderate and moderate potentially even faster. Great for individuals, great for the economy. Not so good for corporate earnings and profitability. Top-line revenues and margins will get impacted if corporations can't hold on to pricing pressure.

Phil: That's right. So, so very interesting let's turn to what we saw in 2022. It's our first webinar of the year, one to look to spend a moment looking backward. So here we are showing long term since 1928, S&P 500 return versus the return of government bonds in the intermediate space of the yield curve. So each dot here is what's the return of the S&P 500 on that vertical axis and what's the return of government bonds on the horizontal axis. So, for example, the upper-right quadrant that is both stocks and bonds have positive returns. Interesting, that's the most common outcome.

Brent: Yeah.

Phil: Fifty eight percent, nearly 60% of outcomes. What's interesting is the lower-left, that is both stocks and bonds have negative return. Yeah, well, unfortunately, that's what happened last year.

Brent: That's right.

Phil: 2022 was wild. Only 4 out of these 95 years has that happened.

Brent: That's crazy.

Phil: If you look at the years represented there, it is decades in between these occurrences. So last year felt really unique, felt like an outlier. We'll talk about that more. Diversification felt like it didn't work.

Brent: Yeah.

Phil: And really, the data shows it is fairly unique.

Brent: Yeah I mean, it's incredible. Long term, if you said that in, you know, 91 of 95 years, stocks and bonds provided a thoughtful ballast between each other in the portfolio construction context, you would say, well, that's pretty consistent. It just unfortunately didn't work. And I think to your point, when you look at the entire right side of that, you know, you know, the sub-zero for US government bonds, just the percentage of time that you had positive returns is outstanding.

Phil: It shows the bonds generally are either positive or very close to zero. Last year was the exception. We'll talk about that more in a moment. So 2022, if we flip ahead, obviously a challenging year across asset classes. What's interesting is, though, this is in total return terms, US large cap stocks fell 18%. What is interesting is you see a lot of negatives here. That's not fun for anyone. But really diversification did help overall return. Mid cap outperformed. Small cap outperformed large cap. Global equity non-US outperformed large cap. All down, right? Painful, just like we showed in the dot plot. But it is interesting, even the AG down less than stocks that you did see diversification working underneath the hood relative to just US large-cap stocks.

Brent: Right, absolutely.

Phil: Also last year, if you flip a head, this is S&P 500 index annual return. So, so one, it's 12/31 to 12/31. Right, so those are the endpoints. Last year was the worst year since 2008.

Brent: Which is just incredible.

Phil: It's one of those things you see reported, and you think, that doesn't sound quite right. And the reason is, in 2020, the stock market sold off over 30%. It's just—

Brent: Fully recovered in 4-and-a-half months, unbelievable.

Phil: It's just that, we recovered in the same year. So we've certainly seen uglier periods recently. Right, before a full calendar year, it was the worst year since 2008 in the stock market. And additionally, as we flip ahead, it was a very volatile year. So here we're showing the percent of trading days with greater than a 1% move up or down. Right, so the gray bar, that's 2022 as high as you've seen in the past. There are a couple of things to note here. One, volatility does tend to cluster. You do see a few really high bars operating in the same back to back. We have said and we said in our 2023 outlook that we do think this is a volatile year. We would not be surprised to see us continue to bounce around, which we have so far this year.

Brent: Yeah, and to your point, when you look at, sort of the late 90s, sort of that '97 through '99, understand that when we talk about volatility, we're not just talking about downside risk. We're talking about, you know, significant upside moves just as much as we're talking about downside moves.

Phil: Volatility does not necessarily mean down and can be up. It just means that you're—the market's moving around a lot day to day.

Brent: Yeah, so let's transition away from stocks for just a moment. Phil, let's talk about fixed income. Similar to the equity story, fixed income had a very, very difficult year. And if you're looking at sort of that middle column and looking at the total return for these various fixed income asset classes in 2022, there's negative signs next to everything, right? What I thought was most interesting is when I look at something like the 10-year treasuries return of -16.5%, compare that to the broad aggregate bond universe, which is only down 13%, but then go all the way down to the bottom and look at something like an asset class, like high yield or sub-investment-grade corporate bonds. An asset class that is historically much more volatile than treasuries, but outperformed government bonds by 5.5%. Even investment grade corporate bonds outperformed treasuries by almost a full percent. So it was a very disjointed year and much of it driven by what you are talking about, which is monetary policy and the compacted nature of those changes into such a tight window. The good news is, when you look at the column on the far right, when you look at current yields, because current yields tend to be a manifestation of forward returns when you run your eyes down the list. Significantly higher yields today than where we were at this time when we started 2022. And just look at the US Aggregate Bond index. 175 at this time, when we started 2022 now on 2023, 4.3% or two-and-a-half times higher yield today in broad, aggregate universe than where we started in 2022. So again, while it was a painful year, much, much better starting point for fixed income going forward.

So when we go to the next slide, Amy, on the left, on the lefthand side, we've talked an awful lot. You know, gray line is the 2-year treasury. Gold line is the 10-year treasury. You can see that incredible move up from the end of November of 2021 into 2022. Just an incredible movement up in rates. And when you look at the difference on that graph on the left, we're showing that on the right, which is the spread between 2-year bonds and 10-year bonds, and we've talked about that inverted and that historically at least a twos, tens inversion tends to portend a recession. What I think is very interesting, if I were to update this on the fly, we are now 70 basis points inverted, which is the most significant inversion that we've seen since the first half of 1981. So it's been a long time. So the extent to which that might signal that a recession is coming, if it doesn't happen, if we don't see a recession, this would be the deepest inversion that we've had without.

Phil: Yeah, that's right.

Brent: So let's talk about the worst year for fixed income. This is kind of looking at the Bloomberg US Aggregate Bond index, which goes all the way back to 1976. You can see on the far right how bad of a year 2022 was. We ended the year being down 13% Phil, intra year. We saw a 17% decline. Move your eyes, folks, to the left. Most of those bars point up and even when you had an intra-year decline, it was 2%, 3%, 4%. And even when that gold bar was down, what was it, 2% down, 3% down. We've been behaviorally conditioned to think that fixed income goes in one direction and that's up. We've had 2 consecutive years of a downturn in fixed income. If I were to change the series to US government bonds and go all the way back to 1784, the last time we've seen 2 or more years of a decline, you have to go back to 1862 to see 2 or more years of a decline in fixed income. So again, knocking on wood that maybe this is the last year that we see a decline in fixed income, but time will certainly tell.

So, Phil, that was a mouthful. That was a lot to cover. Why don't we transition and talk about our views? And Phil, as you and I covered in our outlook, there are five fundamental views that we saw for 2023, certainly not only for this year, but for the full decade. The three that we want to focus on is we certainly want to go over are S&P price target for the 12 month rolling, not fiscal 12 month rolling. We'll talk about that. We're going to talk about how we see more balance between stocks and bonds not only this year, but over the next decade. And we've had so many questions, Phil, like should I be focusing on bonds and not stocks? Should I be moving more of my portfolio from stocks to bonds? We're going to answer all of that. And the answer is no. We'll get there when we get there. And then we'll talk about diversification mattering more in 2023. It's always mattered, but it might matter more this year in the coming decade. So why don't we jump into our price target?

Phil: Right, so let's start with the S&P 500 price target. So as we outlined in December, our base case is 4,100 through yesterday's close, that's up just 2.1%. The reason is through yesterday the S&P was up 4.6%.

Brent: Right.

Phil: Now, now we're down today, so we'll see. But, so clearly the S&P has marched toward our price target very quickly. Our view as we've outlined regularly in terms of a 12-month price target, we do not view us as going there in a straight line.

Brent: That's right.

Phil: We think we've had an up period. We think we're going to have downs. We think it is a bumpy ride this year.

Brent: Volatility.

Phil: That's right. That's right. So in terms of outlining our bear, base and bull and the bear case, basically forward earnings one year out. So think months 13 to 24 down. Forward PE and one year is also down forward PE again, that's price-to-earnings ratio. The dollar, you're, the price you're willing to pay for a dollar of earnings. Right in the base case, we have modest up earnings month 13 to 24 after a downward revision to next year, fairly flat PE and then both earnings and PE up in the bull case. You will notice that it's asymmetric.

Brent: Yeah.

Phil: We have more downside in the bear case than upside in the bull case and that is intentional, that's by design. We do think there are risks out there. 60% chance of recession, for example, earnings revisions, the Fed, you name it. But nonetheless, we do still have upside to our base case.

Brent: Yeah.

Phil: So talking about positives, we've talked a lot of negatives so far. But, you know, if you want to over the next few years, think about reasons for positivity. Let's compare to the current environment for the S&P 500 to the 1970s. We talk a lot about the 1970s in relation to inflation. So here current is the gold line S&P 500, 1970s is the gray line, that vertical line you see there, that is the peak of inflation in these two timeframes. So that was June of last year, let's hope, June of last year in the current period and then November of 1974, in the 70s. If you look at the gray line in the 1970s, over one, still volatile, right, ups and downs, but over a multi-year period you did see pretty good performance. The market rewarded inflation peaking. Right? We have seen it up trade recently, the S&P 500. We shall see if it continues. But there is something about getting past that peak of inflation that is a positive for risk markets.

Brent: And as you can clearly see, it's certainly not a straight line and there is an awful lot of chop, especially as you're getting escape velocity runs, you kind of get by that peak inflation. There's a lot of noise underneath the hood. But again, if history were to repeat, let's hope it falls in the same similar direction.

Phil: And in sort of a similar thought process on the next slide, getting past that last hike from the Fed is a positive. So here we're showing 6 months before and 6 months after that vertical line, which is the Fed, last Fed hike up a tightening cycle. Right, we see is lots of chop or volatility coming into the last hike and then still a lot of chop after, but you tend to see an up trade. Now we have not yet hit the last Fed hike, but it's likely happening the first half of this year, let's hope. That would potentially be a positive for markets as you look out into future quarters.

Brent: So, so let's talk about, I think possibly one of the most important views that we have is the balance between stocks and bonds is going to matter this year and it's going to matter, we believe, for the next decade. But what does that really mean, Phil? So why don't we take a look at this first slide here, Amy? And I think we covered this last time, the decade that ended 12/31 of 2021 was fundamentally exceptional. If you look at that green circle, US stocks annualized Phil for an entire decade at 16.3% per year for the decade. To put that into perspective, the long-term average for US stocks is 10.8%. So you're talking about more than 50% higher per year than the long-term average. And if you run your eye down to taxable bonds, taxable bonds did a pretty modest 2.9%. So where you were on the efficient frontier between stocks and bonds for the decade that just ended mattered materially in the context of the returns that your—

Phil: Very, very widespread.

Brent:—very widespread. It was in the top quartile of widest spreads observed in the last 50 years, really post-World War II. So when we fast forward and we think about what that might mean going forward for this year on the next slide, Amy. Before we get into stocks or bonds this year or for the short term, I want to take a huge step back. And if you look at something like the horizon actuarial study, which is something that we've quoted in the past, which aggregates together 39 of the largest firms that developed forward looking capital market assumptions. When you look at their views for the next 10 years or the next 20 years, there is not one market forecaster that believes that stocks will not outperform bonds over the next 10 years.

Phil: Yep.

Brent: So let me say that again.

Phil: Long term.

Brent: Long term. There's not one forecaster that believes that stocks will underperform bonds over the next 10 years. For the forecasters and there's probably eight or nine that we follow that have shorter-term horizons about 5 years. Right, there is not one forecaster over the next 5 years that believes that stocks won't outperform bonds. Whether that's the case or not, Phil? Only time will tell. But this isn't a matter of, hey, I love stocks and I didn't like bonds. Now I love bonds and I don't like stocks. It's like your children, Phil, you have to love both equally, right? Where they fit in your portfolio is a manifestation of your needed rate of returns, your financial planning and your goals and objectives in the IRR you need to achieve and see that all of them come through to fruition. So at the end of the day, what do we see over the short term? If you look at the view that you just covered, which is roughly 4,100 in the base case, consensus top-down views has S&P 500 at about 4,087 over this year. Fixed income, yielding at about 4.3%. Having had 3 consecutive years of a sell off. Will bonds outperform stocks this year? We don't know. Nobody really knows. Time will tell. But again, when we think about it, we know that this year will be volatile. And if you haven't done financial planning and you haven't thought about having a nice cash buffer to make sure that you need to immunize some of those liabilities that are very short term. Making sure that you have the proper balance between stocks and bonds because that gapping has gone from wide to tight over the next decade, which basically means that you should have both of them represented in your portfolio.

Phil: So I guess to put a bow on it, you know, absent of financial planning, should clients just move from a 60/40 to a 40/60?

Brent: Absolutely not. It really depends on your time horizon. We believe that if you're going to invest in the equity market, you need to have a time horizon of at least 5 years or more. So when we go back and look at 150 years of data having a time horizon in holding stocks inside of 5 years and having only that time horizon can prove volatile and challenging, it doesn't mean it won't work out, but it can prove volatile and challenging. So we believe for that reason, you need to keep your long-term allocation. And I think that's one of the beauties of what we do in the context of portfolio construction, is making sure you know what to own, when and how much and having that right balance.

Phil: That's right. So that's between stocks and bonds. Let's talk about diversification within a balanced portfolio. So on this table in the next slide, Amy, we're showing what is referred to often as the lost decade. So it's end of '99 through end of 2009 in which US large-cap stocks, as you can see here, annualized and -1% return, but not a fun period.

Brent: Right.

Phil: One thing we always like to point out as a reminder is this decade started with the tech bubble exploding and ended with the great financial crisis.

Brent: Wow, what a bookend.

Phil: Yeah so. So, you know, I mean, there are obviously up periods during this time as well, but really a pretty extreme period. But nonetheless, let's talk about diversification, which has really not been the name of the game the last 10 years. It's been very much a US large-cap story.

Brent: That's right.

Phil: But starting last year, and we think going forward, it becomes much more interesting in terms of diversification. So going back to the lost decade. S&P 500 -1%. But look at mid cap positive 6.4, small cap plus 6.3, global non-US, positive. US aggregate, positive 6.3. So you're talking, what, 4% to 10% per annum greater return than S&P 500. So it's a reminder that in times of uncertainty, like what we're entering, diversification really is key. I mean, how does that feed to how we build?

Brent: Yeah, that is the key tenet of our portfolio construction process. We do not believe in a static set-it-and-forget-it portfolio. We're using our forward-looking capital market assumptions and dynamically optimizing those portfolios every single quarter to make sure that it's reflective of what's coming at us, Phil, and changing the underlying mix of those asset classes to be reflective of what we believe you need to own when and how much. It doesn't mean that we're trading every single quarter, but we're making sure that we're constantly updating this with the most recent data to be reflective of driving the car, looking through the windshield, not the rearview window.

Phil: That's right.

Brent: So we've probably got what, Phil, three, four questions on, should I get out of stocks now? Should I get into stocks? Should I get out of bonds? Should I get into bonds? At the end of the day, timing when to get out of markets and conversely back in rarely ever works. So think about it in sort of common-sense language. If there existed a person or firm that could consistently time when to get out and back in with any modicum of consistency, how much assets would they manage and what would they charge?

Phil: All the assets.

Brent: All the assets. And they would charge an awful lot. Right?

Phil: Right.

Brent: You just can't do it. Right, so we don't think you should do it. So what we're looking at here is the last 25 years, from 1992 through 2021. If you put $10,000 in the S&P 500, again, it's an investable index, you can't actually do it. You have to own an ETF or a fund or something along those lines. But if you hypothetically did that, your $10,000 investment would grow more than 20 times to $208,000. If you missed 10 of the best days out of those 25 years, you had less than half your money. And God forbid, if you missed 20 of the best days, you had almost three-quarters less money. And when you look at the box on the right, Phil, when you think about almost half of the S&P 500's best days occur during a bear market. Another 28% of the S&P 500's best days occur 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 days occurred when you'd never want to be an equity investor. So the name of the game is having a financial plan, having a thoughtful asset allocation that gets you to those long-term goals and objectives, and stay invested because markets will be volatile. You cannot time, nor can anybody, when to get out, when to get back into markets. So please, for the love of Pete, do not do that. So with that, Amy, I can see all the questions lining up on the righthand side of the screen. Why don't we start the Q&A?

Amy: Sounds good, Brent. Yeah, we do have a number of questions. We also received several in the registration process. Just a reminder, if we don't get to your question today, please reach out to your First Citizens partner. Brent, we just hit this over the head a little bit, but already have a bunch of questions kind of around the same thing. Given the bumpy ride of stock market, of the stock market in the last year, are bonds a better alternative?

Brent: That's a great question, Amy. I think for everybody in the context of the financial plan, you always need to have a slush account or a savings account that has x number of months or quarters, maybe even years of sort of that cash reserve to make sure that you can take care of very, very short-term liabilities. Right but again, as we were just talking about, Phil, it's not about tactically timing stocks or bonds. The good news is, is that for not only this year but over the next decade, we believe both stocks and bonds will be good.

Phil: Right.

Brent: Right, they will both be just good together. Right, so it's like loving both of your children. You should have both of those in your portfolio in a nice, healthy balance that gets you toward your goals or objectives versus what you saw with a decade that ended, which everybody just fell in love with stocks for the entire decade and you got rewarded handedly for owning stocks more than bonds. We think that that spread comes in materially, not only this year, but over the next decade. So it's not an either or, Amy. It's loving both and making sure that you have both of them in your portfolio in a thoughtfully diversified manner.

Amy: Brent, we talked about this, touched on it just a little bit. But given today's headlines, it's no surprise. We've got a couple of questions around the debt ceiling. What preparation, if any, should people take to protect themselves in case Congress fails to act on the debt ceiling?

Brent: Yeah, political volatility, Amy, is it seems like, you know, omnipresent, right? It's something that we're dealing with a lot. So let's just let's talk about the facts and understand this. We've been dealing with debt-ceiling issues since the early '50s. Right, we've been there two times where things got a little squirrelly. Right, 1953. Right, we had an issue in late summer, early fall. Didn't get resolved until the summer of 1954. So things got a little bit squirrely. Then we had, I think it was 2011, Phil.

Phil: Yeah.

Brent: Where we had a downgrade, and a little bit of an issue.

Phil: Fun summer.

Brent: Fun summer, for sure. Here's the deal, right? It's going to be a hotly debated topic. The good news is, at least when you listen to the political press, it seems that President Biden and, and Speaker McCarthy are already on it and have both verbally said that they were going to get together to try and do something about it. At the end of the day, we do believe that there will be a resolution. We don't believe it's going to end in anything catastrophic. Also, additionally, when you think about whether it's a corporate bond or a sovereign obligation, the underlying risk or the probability of an outcome tends to be priced into their yields. Right, if you think a company's going to default relative to their price today, you would demand a higher yield for that same given what you expect to happen. If the market really believed that the debt ceiling was going to be a fundamental issue that would impair the value of US government securities, we would probably see more of that priced in to the 10 year or the entire Treasury curve. We're not seeing that. We're seeing yields fall, as you nicely highlighted, Phil.

Amy: So Phil, let's jump to you. Historically, as fixed-income markets improve, it attracts more cash. How do equity markets fare when that happens, when that shift changes?

Phil: That's a really good question. I think if we flipped to slide 12, it does show sort of what we're talking about. So what's interesting is it's not either or as Brent mentioned, in terms of his love both your children, metaphorically.

Brent: They're watching this.

Phil: So, so if you look at these dots, 58%, so pushing 60% of these dots are in the upper-right quadrant, mean both stocks and bonds perform well. So in any given year, odds on stocks and bonds perform well. Then, of course, there are periods in which one or the other do, but we don't think of it as an either-or. It's interesting that's become really the topic in the marketplace, because the truth is, majority of years, they both perform well. We think it's much more important to think about the long term. Right, and think about what your goals are and think about what the construct is there. Flows from stocks to bonds, really, I don't think pushes markets. There's not much statistical evidence that flows in and out of mutual funds and equities, for example, even drive equity performance. You can have lots of outflows and the market's going up. Right, we saw that after the financial crisis. So I wouldn't worry too much about it's one or the other. I'd worry more about my overarching allocation. And does that make sense for the long term?

Brent: Yeah and I would say, again, it's loving both making sure that they're both in the portfolio. What I will say, though, is expectations for both stocks and bonds. We all have to bring our expectations not only for this year and the entire decade, lower. We're still thinking it'll be a good return over the next decade and also for this year. But I'm pretty confident that we're not going to see 16.3% for an entire decade. There is a lot of things behind why that occur, but we do believe that you'll get a nice return in both stocks and bonds over the next decade.

Phil: One can hope, Brent.

Brent: That's right. I'm going to knock on wood.

Phil: That's right.

Amy: Phil so we've been watching the Fed raise rates over the last year. More and more experts are saying that rates could top 5%. How do we see that going, and what might that mean for short- and long-term rates?

Phil: Yeah, I see questions in the queue on long term rates as well as I kind of tackle both. So first short term, I touched on this, but, but just to dig in a little bit more, the Fed is telling us they're going to get the overnight rate, the Fed funds rate north of 5%, just slightly. The 5 to five-and-a-quarter range. Futures are saying they're only going to get to the four-and-a-quarter to 5% range. Right now, they're at the four, I'm sorry, the 4.75 to 5%. Right now, the top of the range is 4.5%. So basically futures are saying you're only going to get another half percent. They're saying we're going to do more. Either way, the question that said 5%, that's about right. Right, that's about right. That does not say much about longer rates.

Brent: That's right.

Phil: So think about the 10-year treasuries, sort of the benchmark, we all think about a lot of stuff is correlated with it. Mortgage rates, for example. The 10-year treasury peaked last October at pushing four-and-a-quarter. Right, as of this morning, it was at 3.4%.

Brent: Yeah, that's a material move.

Phil: So it fell from four-and-a-quarter to 3.4% as the Fed hydrates. Still, remember, just because the Fed's hiking does not mean interest rates across the yield curve and across the economy go up. It means the overnight rate goes up. Those are two very different things. What could push, what one, what is pushed the longer-term rate down and what could push it up? Well, longer rates have come down as market participants have become worried about future growth. Right, and if you're worried about future growth, what do you do? You think interest rates are going to be lower in the future and you buy treasuries?

Brent: That's right.

Phil: Right. Now.

Brent: That pushes the yield lower.

Phil: That pushes the yield lower. Right, so that's what we've seen. What could push it up? Well there's one outcome that's very positive, which is a reexamination of growth expectations. In that case, longer-term rates go up. The yield curve goes from severely inverted to potentially positive.

Brent: Yeah.

Phil: Right. The negative, of course, would be is if inflation does not continue to cooperate, that could also push longer rates higher. But right now, it does feel like we are in a long rate lower environment as people buy treasuries, you know, as safe havens.

Brent: Absolutely especially for some of our institutional clients. Right, if you look at something like the Milliman 100 study of, you know, large corporate DB plans, funded status is average about 98%. So as you think about hedging that risk, using longer corporate bonds, longer treasuries, there's a lot more demand as the funded status for a lot of those plans remains high to sort of try and lock down those liabilities in the future. And thinking about where rates might not be this year or next year, they're looking much further out and thinking about where we are in the cycle and taking advantage of that.

Phil: In the fourth quarter of last year, 10 years at four-and-a-quarter, that's attractive potentially no matter what the Fed's doing to some of these clients.

Brent: Absolutely.

Amy: Phil, we've got a question here around the housing market. It sounds like this person's missed out on a couple of job opportunities because they weren't able to relocate, largely in part because the market around housing is so tight. What, if anything, could cause the market to unclog?

Phil: So it's a good question and certainly something a lot of people are struggling with. So there's sort of two layers to the question. First, affordability. So home affordability has fallen precipitously for two main reasons. One, mortgage rates going up, right. And two, home price appreciation going up in recent years. So the asset's more expensive and it costs a lot more to finance it. That has hurt affordability. So that is a headwind. The second problem is inventory.

Brent: That's right.

Phil: So we are seeing the pace of sales decline, both existing and new. There is no question the housing market has already slowed and is probably going to continue to do so. What's interesting is the inventory of homes as of December was higher than the prior December, so is higher than December of 2021 and December 2022. But it was still lower than it was before the pandemic.

Brent: Right.

Phil: Lower than it was December 2019. Why is that? Because unlike 2008, we just have a very tight inventory picture. So the question of unclogging. One it's unclogged a little bit. Right, months' supply has gone, months' supply of homes has gone up as sales have fallen, inventories risen a little bit. But a major declogging probably is going to take a long time.

Brent: Absolutely.

Phil: Because with the housing market slowing, with financing rates up, why would a developer build an enormous development? Now, it always depends on where you live, of course.

Brent: Unless you're in Cary or Raleigh.

Phil: That's right, but in that mess, that is going to be less of that. We're seeing fewer housing starts. The data is showing it. So the answer, unfortunately, is things are probably going to stay pretty tight in the housing market.

Brent: And joking aside, I think you are talking predominately at a national level, right. So it's important to be regionally specific. Right, certain areas of the country will probably decelerate or probably maintain pricing for quite, quite some time. It's really regionally specific.

Phil: Housing always is.

Brent: Yeah.

Amy: Brent, Phil, thank you so much. We will go ahead and wrap up. We've got, if your question wasn't answered, please reach out to your First Citizens partner. We've got several things that are coming your way this year. Please stay tuned at, including our next webinar, which is scheduled for February 22. There'll be more information coming out to you all in the coming weeks on that. I just want to thank everyone again for being on the webinar today. And we look forward to seeing you throughout the year. Thanks so much.


The views expressed are those of the author(s) at the time of writing and are subject to change without notice. First Citizens does not assume any liability for losses that may result from the information in this piece. This is intended for general educational and informational purposes only and should not be viewed as investment advice or recommendation for a security, investment product or personal investment advice.

Your investments in securities, annuities and insurance are not insured by the FDIC or any other federal government agency and may lose value. They are not a deposit or other obligation of, or guaranteed by any bank or bank affiliate and are subject to investment risks, including possible loss of the principal amount invested. Past performance does not guarantee future results.

First Citizens Wealth Management is a registered trademark of First Citizens BancShares, Inc. First Citizens Wealth Management products and services are offered by First-Citizens Bank & Trust Company, Member FDIC; First Citizens Investor Services, Inc., Member FINRA and SIPC an SEC-registered broker-dealer and investment advisor; and First Citizens Asset Management, Inc., an SEC-registered investment advisor.

Brokerage and investment advisory services are offered through First Citizens Investor Services, Inc., Member FINRA and SIPC. First Citizens Asset Management, Inc. provides investment advisory services.

Bank deposit products are offered by First Citizens Bank, Member FDIC.

See more about First Citizens Investor Services, Inc. and our investment professionals at FINRA BrokerCheck.

Balance between stocks and bonds will matter in 2023 and beyond

In our January update, we covered three main topics.

1. Key economic factors

Growth across global developed markets is expected to slow materially from 2022 into 2023. Specifically, consensus expects modest growth in US real GDP for calendar years 2022 and 2023 (2.1% and 0.5%, respectively).

The path of inflation is expected to continue its decline. Since its June peak of 9.1%, inflation has fallen each month, with December's reading at 6.5%. We believe this trend will continue in 2023.

The labor market continues to be tight. The number of job openings per unemployed person is 1.74, meaning there's almost two open positions for every unemployed person. Despite layoffs in some industries, the unemployment rate is at 3.5%. For perspective, the 50-year average rate is 6.2%.

2. Market observations

2022 was truly an outlier. Just 4 out of 95 years saw negative annual returns for both stocks and government bonds, including last year.

The turbulent year created a great starting point for the next decade. US fixed income had a difficult year in 2022 from a total return perspective. Despite the disjointed nature of returns, 2022 saw significantly higher yields than in the previous year. Current yields tend to be indicative of forward returns.

3. Our views

In our 2023 market and economic outlook, we covered five views for 2023. In this month's discussion, we focused in on three of them.

Our base case S&P 500 price target for the next 12 months is 4,100 (+2.1% from close on January 24, 2022).

We believe the balance between stocks and bonds will matter greatly in 2023 and beyond. Stocks returned 16.3% (~51% above long-term average) in the 10 years through 2021. Aggregate bonds are yielding 4.3% today, compared to 1.03% during August 2020.

Further, we believe diversification within a balanced portfolio will matter in 2023 and beyond.

Bottom line

We believe markets will experience a bumpy road this year. Having the right balance between stocks and bonds as part of a thoughtful and strategic financial plan can help you reach your return goals.

This information is provided for educational purposes only and should not be relied on or interpreted as accounting, financial planning, investment, legal or tax advice. First Citizens Bank (or its affiliates) neither endorses nor guarantees this information, and encourages you to consult a professional for advice applicable to your specific situation.

Links to third-party websites may have a privacy policy different from First Citizens Bank and may provide less security than this website. First Citizens Bank and its affiliates are not responsible for the products, services and content on any third-party website.

Your investments in securities, annuities and insurance are not insured by the FDIC or any other federal government agency and may lose value. They are not a deposit or other obligation of, or guaranteed by any bank or bank affiliate and are subject to investment risks, including possible loss of the principal amount invested. Past performance does not guarantee future results.

First Citizens Wealth Management is a registered trademark of First Citizens BancShares, Inc. First Citizens Wealth Management products and services are offered by First-Citizens Bank & Trust Company, Member FDIC, Equal Housing Lender; First Citizens Investor Services, Inc., Member FINRA and SIPC, an SEC-registered broker-dealer and investment advisor; and First Citizens Asset Management, Inc., an SEC-registered investment advisor.

Brokerage and investment advisory services are offered through First Citizens Investor Services, Inc., Member FINRA and SIPC. First Citizens Asset Management, Inc. provides investment advisory services.

Bank deposit products are offered by First Citizens Bank, Member FDIC.

See more about First Citizens Investor Services, Inc. and our investment professionals at FINRA BrokerCheck.