Making Sense: June Market Update

Amy: Hi. I'm Amy Thomas, a strategist here at First Citizens Bank. Today is June 28, 2023, and I want to welcome you to today's monthly making sense webinar, where Chief Investment Officer Brent Ciliano and Director of Market Economic Research Phil Neuhart provide their insight to help make sense of what's going on in the markets and the economy. First, we received a number of questions from you all in our registration process. We will answer as many as possible during today's recording.

We do 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 discussion, please reach out to your First Citizens partner. And lastly, as always, the information you're about to hear are the views opinions of First Citizens Bank and should be considered for educational purposes only. Brent with that, I will turn it over to you.

Brent: Great, Amy. Thank you so much. Good afternoon, everyone. Hope you are well. Phil, I cannot believe that we are halfway through the year already. What a difference from a market and an economic perspective this first half has been since last year?

So we've got a lot to cover. We're gonna start first with an economic update. We're gonna talk about the trajectory of US growth. We're gonna talk about financial conditions, and monetary policy. We're gonna talk about inflation like we've talked about on mostly every WebEx. We're gonna talk a little bit about core inflation this time around the ever-important consumer and labor market than residential real estate and commercial real estate. Then we're gonna shift gears and give you a market update gonna give you a summary of the first half, and we're gonna talk about the durability of this rally year to date for equity markets.

Then we're gonna pivot, talk a little bit about earnings and valuations. We're going to do an out new update on our S&P 500 12-month rolling price target and talk about fixed income markets as well. So a lot to cover Amy, so why don't we jump right in?

So, the US economy, Phil, is slowing. The broad trajectory for both US manufacturing and services is one of continued moderation. And what we're looking at here, the gold line is US manufacturing. And you can see, Phil, from the highs that we saw back in March of 2021, we've seen some significant moderation in manufacturing. We are now in contraction territory. Remember, folks, a reading above 50.0 denotes expansion, below 50 is contraction. And you can see that we're modestly in contraction territory for manufacturing services after the high that we saw back in November 2021, has also moderated lower a little bit more volatility there, Phil, now sitting at about 50.3. We're going to be getting readings on July 3 and July 6, respectively.

So we'll have to see what those readings are and where we progress from here.

So one of the things that we've highlighted quite a bit, Phil, is the speed and magnitude of this rate hiking cycle. And then the gold line here is this cycle. And we're looking at all rate hiking cycles post the early 80s bill. And you can just see with that gold line, how fast and how high the Fed has taken us, you know, this time around, which is which is sort of led to that slowing of economic conditions.

Phil: And look at the just the speed of the hikes. And then keep in mind that that monetary policy impacts the real economy with a lag. 12- to 18-month lag. They didn't even start hiking until last March. Yeah. Right. So much of the impact of these hikes are just now being felt. We have a ways to go in terms of the impact of monetary policy on the economy.

Brent: Right? And one of the feedback loops from, you know, Fed rate hikes is tighter financial conditions on the next slide, Amy. And, Phil, you and I covered this last time. But when I look at, you know, US commercial bank loans and leases and the tightening in credit, and you can see that little circle there. The last two weeks of March saw the sharpest contraction in commercial loans and leases in more than 50 years. And it's just an incredible move. We believe that broadly, financial conditions will remain tight as long as rates remain high. And as we'll cover in just a bit, we believe the Fed is likely to keep rates high for a much longer period of time.

Phil: And look, this this severe tightening is equivalent to some number of Fed rate hikes.

Brent: That's right.

Phil: So you think about the Fed pausing in the most recent meeting. One of the reasons is financial conditions tightened. That is equivalent to some monetary policy tightening, and they're able to take advantage of that.

Brent: Yeah. And, you know, the confluence of fan rate hikes, Phil, tighter financial conditions on the next slide, Amy, is economists and market participants' expectations on the future path of rates. And we changed up the picture a little bit here, Phil, we used to have bars. We've seen such extreme volatility in expectations. We change it here to sliders. So on the horizontal axis, we're looking at future fed meetings, right? The next one in July 26 all the way out to the first meeting in 2024—that gray bar is the range of outcomes that we've seen for each one of these future meetings. And you can look at that very first bar right before that we had some banking issues, back on March 8. The market participants expected, you know, the implied rate for Fed funds being about 5.7%. A week later, it was almost 4%. So almost 150 basis point spread in a week between those expectations, and you can see the length of those gray bars as you go through time.

The important thing I think that we need everyone to focus on are the gold triangles, which is where expectations are today. And if you drew a dotted line across 5%, you can see that expectations for rates between the next Fed meeting and the first meeting in January of next year is solidly anchored at about 5%. And not to take a victory lap here, Phil, but we've talked about the Fed not unwinding all that heavy lifting and hard work and bringing rates back down too early when inflation has been persistently sticky.

Phil: And now the market expects the Fed to remain pretty persistently hawkish.

Brent: That's right.

Phil: And so what does the market think versus what the Fed thinks? So if we turn to the next slide, thank you, Amy, is if you if you look at the last meeting, the Fed released what's called their summary of economic projections. And in that, they have a year-end number for the Fed funds rate. And they raised that more than expected, really indicating two more hikes. And that's what you're seeing in the gold line here. This is what they're saying the Fed funds rate is at the end of the year. What's interesting is the gray line is sort of tied to what you showed on the last slide, which is the terminal rate. In other words, where does the Fed stop hiking? What does the market think the level of the Fed stops hiking is? Well, what you see is the great line's below the gold. In other words, the market does not believe that the Fed is gonna hike twice more this year. Right now, the market believes once. When you think about how risk markets have behaved even after a more hawkish expected Fed in in the June meeting. Some of it is, they just aren't really buying what the Fed's selling. So we shall see, market you can see us gray lines move around a lot. Right. But for now, the market is somewhat skeptical of what the Fed is saying. So all this Fed hikes as we flip ahead is due to inflation, right? CPI peaked last June at 9.1% as you can see here in the gold line, it has fallen for 11 consecutive months all the way to 4%. So, we've done a lot of heavy lifting on the inflation front.

Brent: None of the economists would have expected back then that a year later from that high of 9.1 that would be sitting at 4%. That that's our movement.

Phil: And when you think about, you know, why is the start market up to the extent it is, since last time I'm hoping, well, this is part of the story. Now, the less positive part of the story is core CPI. That's the gray line. That excludes food and energy. Sort of underlying inflation, very important to the Fed. It never reached the highs of headline inflation, but it is now above headline inflation. So when you hear Chairman Powell say things like underlying inflation stickier than you would like, well, this is what they're pointing to is core inflation.

So let's dig in to core inflation on the next slide. A really important component of core CPI is rents and owner equipment, over 40% of CPI is just rent and owner's equivalent rent. Both these measures, the way the government measures them, is somewhat controversial. If you just take actual core CPI, that's the goal line here. You take out rents and you replace it with a market metric, like Zillow rents. That's the dotted line. You'll notice, first of all, of course, CPI understated inflation for about 18 months, but now it's overstating inflation. Rents in measures like Zillow rents, home prices and things like Case-Shiller, year on year we are seeing pretty precipitous moderation. That would mean that core inflation should move lower, and underlying inflation may be a little bit better than we would think otherwise.

Brent: Yeah. And it's absolutely not the level. I mean, I would say from here, it's the directional vector of the public market data that should hopefully feed back into the official governmental data.

Phil: That's correct. So what about the direction and the level of forward-looking consumer price index? So, this is consensus estimates, which by the way, were very wrong, call it 18 months ago, but have been much more on track, let's say, over the last few quarters. So consensus expects one, that inflation is gonna move closer to 3% by the end of this year—we're at 4 percent today—and that we're between 2 and 3%, really a two handle in every quarter of next year. That would be very, very positive in our view. We'll talk more about the market implications for that later, but we do think that inflation will continue to moderate outside of an exogenous event.

Brent: Yeah. You don't see 2% up here, Phil. Even going out to the fourth quarter of 2024, and whether we get there time, we'll certainly tell. And I think, to your point, much of the heavy lifting has been done. As we get into 2024, there's gonna be a lot of base effects that are gonna make it harder to see that extreme type of fall in inflation. It's going to be potentially more moderated or muted as we go forward. But again, the directional vector on inflation is moving in the right path.

So let's talk about what's been incredibly resilient, Phil, which is our labor market. Right? So the May print for payrolls came in at 339,000. The consensus expectations, Phil, was for a 195,000 jobs. So again, another knockout month. We're expecting the next print on July 7. We've been running over 300,000 on a 6-month moving average, and remember you need about 100,000 jobs per month just to keep the unemployment rate from moving up. What I thought was really, really interesting, Phil, is that in 12 of the last 13 months, consensus expectations from thoughtful economists have underestimated the actual print of payrolls in 12 of those 13 months. So again, we have a, you know, next print coming up, 200,000. I don't know if, Phil, if you wanna take the over under on whether or not we'll be above that. But again, a very strong and resilient labor market.

When we think about maybe some things underneath the surface, Phil, that we've been observing initial jobless claims has risen and has been elevated. But if I go back to the September 22, of 2022, low of 182,000 jobs, which just as a reminder is near the lowest print that we've seen since the data started back in the 60s. Right? We are moving, yes ,higher but off of a very low base. The long-term initial jobless claims average going all the way back to the 60s, is 380,000 jobs. So again, yes, we are starting to see initial jobless claims move higher, but off of near-historic lows, and nowhere near the long-term average. So again, something that we're gonna be monitoring, but nowhere near average levels.

So what's really important is the consumer, Phil, and certainly consumer spending. And remember, consumer spending accounts for more than two-thirds of US real GDP. So as goes the consumer, as goes growth. And what we're looking at the chart on the left is personal consumption expenditures. The gold line is spending on goods. The gray line is spending on services. And what you can see is from the from the highs that we saw back post-pandemic, Phil, we've seen again—similar to manufacturing and services broadly—moderation and spending. But when you look at good spending relative to the 20-year average, we've now, Phil, dipped below that long-term average. But on the services side of the equation, we are still almost double the long-term average. So the good news is that when I bifurcate total consumer spending, about a third of spending is on goods, two-thirds on services. So it is good to see that the one element that's hanging in there, services, is the bigger component of that.

On the righthand chart, we're looking at we showed this last time, Phil, the Visa US spending momentum index, which is nothing more than looking at spending on credit cards for both, you know, online, bricks and mortar, et cetera et cetera. And what we're trying to look at here is the momentum of spending. A reading above 100 is you know, positive or increasing momentum, a reading below 100 is decreasing momentum. So not the absolute level, but just that momentum index, and you can see what we've had a decrease in that fundamental momentum in spending. We're gonna be getting retail sales soon. So time will tell as to what consumer can continue to hang in there.

Phil: Look, even the most recent retail sales data show can still grow but at a slower pace. So, it's consistent with what the Visa data is showing that it's growing, that's good. But certainly, there is some pieces coming out of consumer spending.

So let's turn to the housing market for a moment here. So we really have a tale of two cities in the housing market, the existing home market, the new home market. So what is happening? One, existing home sales on the left side here. You can see, of course, this fall precipitously. Why is that? There's a few things going on. One, of course, affordability is low because of price appreciation in higher mortgage rates, but also there's very little supply, right? People locked in low mortgage rates and are very hesitant to list their home. That has impacted existing home sales certainly dramatically. What's interesting, you can see this on the right side, is that limited supply is driving new construction. We're showing housing starts on the right side. So think new home construction, that has really rebounded and is really basically back to pre-pandemic levels, really pre-pandemic highs, whereas existing home sales are not even close. What has that driven? That's driven new home sales, right? The market's so tight that once that home is finished, it's getting sold. So new home sales have also been boosted. So this is good for the economy. New construction is good for the economy. That finds its way into GDP. So the housing market, when you when you think and you hear there's some positivity there, it's really about this new construction. Now the commercial real estate property market is a different—

Brent: Different story.

Phil: —different ballgame. Here, we're showing price appreciation. We show any number of metrics. But year on year, of course, quite a bit into negative double-digit territory on price appreciation. There's been a lot of focus on urban office, for example. And then there's certain cities that are pointed at often, but it's really across a number of cities is the truth. But it's not just office, right? Depending where you are geographically and where within a metro area, apartment in certain places, retail, et cetera. So it's somewhat broad based when you think about concerns, for the economic outlook, certainly commercial property has to be on that list.

Brent: Right.

Phil: And then speaking of which, we often speak to the idea that we have a 60% chance of recession next 12 months in our view. Consensus is at 64, 65% percent. So consensus is odds on recession, but not a slam dunk.

Brent: Correct.

Phil: So what we want to do today is really list positives in terms of how we avoid recession and negatives, things that could potentially pull us into a recession. So Mr. Positivity, do you wanna go ahead and start on the avoid receptor?

Brent: Absolutely. As I've covered, you know, we've seen an incredibly resilient labor market and a very strong consumer, Phil. And as we said many, many times, the consumer is the lion's share of US real GDP, and it really will drive the in our opinion, the direction of where our economy goes. And the consumer is still flush with cash, still spending, still getting a paycheck, still employed. We think as goes to consumer, as goes to our economy, We talked about the service economy and spending within the service economy, spending being almost double the long-term average, and broad services still doing okay. And as you mentioned really nicely, residential construction is hanging in there because of that lack of supply. So there's a number of things that would could potentially point to avoiding a recession, or at least a softer landing.

Phil: And then on the certainly negative side, much of which we come today—I won't dwell—but tighter monetary policy. The tremendous hiking is takes time for that monetary policy to feed into the real economy. We're still in the early stages of that. Tighter financial conditions, bank lending, as you mentioned. The manufacturing economy. We showed ISM manufacturing. We've been in slowdown there for a while.

Brent: Yeah.

Phil: It's a smaller portion of our economy, but still matters. The inverted yield curve.

Brent: Yeah.

Phil: That has been there for a long time—

Brent: Yep. Significantly.

Phil: And inverted yield curves tend to point to future recession. This would really be the exception to the rule if we don't have one. And then commercial property. We just touched on it, but clearly a no risk, but you can't ignore the commercial property market when you think about risk of recession.

Brent: Correct. So Amy, why don't we shift gears and let's talk about the market? And what I wanna first start talking about, Phil, is on the lefthand side. Let's talk about a recap of last year's first half versus this year's first half. Certainly, a tale of two halves. You can see last year at this time, US and international stocks down significant double digits, down almost 20%. Fixed income, rarity, down 10%. So diversified portfolios did not fare well through the first half of last year. Fast forward to this first half, significant change of events. And if I update this on the fly through last night, we're looking at almost 14% up for US stocks. Almost 9% up for international stocks and fixed income, modestly positive will cause taxable and municipal bonds. So definitely different.

On the righthand chart, again, from the October 12 of last-year lows, Phil, 35 37, were up nearly 24% percent from those lows. So again, significant movement off the volatility that we saw last year, and I'm knocking on what as we're saying it, let's hope that the trend that we're seeing this year persistence in the second half as we continue to go through.

Something on the next slide, Amy, that we've seen a lot in the financial news media we even talked about this last time, Phil, in in our making sense video, was the narrowness of this rally year-to-date. What we're looking at on the righthand side is a technical measure, which looks at the percentage of S&P 500 stocks actually outperforming that broader index. So think about the individual stocks in the index, and what has their performance been relative to the broad S&P 500 index? And you can see that little tail at the end, about 20% of stocks are outperforming that broad index, which is one of the lowest readings that we've seen in the last 30 plus years. And the broader, you know, financial news media narrative is, is that a bearish indicator for stocks because of the narrowness of the rally? What you're looking at in a chart on the right is taking the next 6 months' performance off that indicator and breaking it up into deciles, you know. On that first decile, which is sort of that lowest reading all the way up to the highest decile, which is the highest percentage of stocks outperforming, you can see that narrowness or the percentage of stocks not outperforming the S&P 500 is actually historically, Phil, been a bullish indicator for the next 6 months performance for the S&P 500. So, despite the lack of stocks outperforming the broader index, at least historically, the lower decile readings have portended better returns for the next.

Phil: So what does that mean? It means a narrow rally broadens out. And there were some early indications of that happening in the current marketplace as well.

So that's price. Let's talk earnings on the next slide. Something we talked about coming into this year was the idea that we needed to see downward earnings revisions. Earnings just seemed too high. And we started to see that late last year. As you could see here, we're showing 2023 and 2024 earnings per share for the S&P 500 through time. And you can see earning commissions began in earnest back half of last year, continued into this year as well. That has started to flatten, and we think that's a good sign. We think that there could certainly be forward revisions. We don't want to say that there wouldn't be a particularly 2024 number.

Brent: Right, for sure.

Phil: But we are starting to see a flattening. That means that we think analysts have become a little bit more reasonable in terms of their expectations. That is a positive for the marketplace.

So let's talk valuation. When we say valuation, when do we mean? Well, here what we're showing is next 12-month price-to-earnings ratio for S&P 500. All that is the price the market's willing to pay for a dollar of forward earnings. Right? So, when this number high, it's expensive. You're paying more for a dollar of earnings. When it's low, it's cheaper. We had, as you could see here, in the 2020, late 2020 through all of 2021, a very expensive market. Right? This is very expensive even versus historical context. We, of course, had a drawdown last year. The valuation fell to 15.5 times earnings. Now we have seen expansion, right? So the market's trading about 19 times forward earnings. That is expensive by historical context. But still, better than where we were a couple years ago.

Brent: That's right.

Phil: But it would be very difficult to describe this market as cheap.

Brent: Yeah. Sure. Sure.

Phil: It is a fully valued market. So, when you're thinking about performance, the 14% gain this year has pushed valuation up to some extent, certainly.

Brent: Yeah. And the big question is, right, our earnings after what you just talked about in the previous slide, going to come up to meet valuations and normalize the valuations that we see. Or vice versa. So I think that there's a lot of uncertainty that would that we will have to just wait and see.

Phil: Absolutely. So what's one fundamental driver evaluation in our perspective on the next slide? Inflation. Right? So here, the horizontal axis, we're showing different inflation buckets, negative less than zero, for example, zero to one, one to two, since than 1920. And then the the vertical axis, on the left side, this is the PE ratio for the market in those various buckets. So, we think we're coming from a 1 to 2% inflation environment. Think pre the explosion in inflation.

Brent: That would have been there for at least 20 years?

Phil: Yeah, before the pandemic. Obviously, we've had an explosion in inflation, which did impact valuation last year. We think we're moving to more of a 2 to 3% regime, right, on trend. Probably starting next year, we don't think room will be in the very low inflation world. So what do you notice? One valuation falls, right. You have a very expensive 1% to 2% market, cheaper 2 to 3%. This is between 17 and 18 times 2 to 3% inflation. So below where we are today, but elevated versus the other periods you see here, except for the 1 to 2. In other words, you can justify a somewhat expensive market versus long-term history. But nonetheless, someone expensive today. So all those fundamentals bring us to our price target. So we, first of all, have a rolling 12-month forward price target. We do not do a year-end price target. Our target rolls through time. So when we are looking at price target today, we're really looking to middle of next year, right? June of 2024. We came into this year with a 4,100 price target at the, from December 31, that would have indicated about a 7% gain, So we thought it was gonna be a pretty good year in the market. It's been far better.

Brent: Yeah.

Phil: Right? So it's nice to be wrong in that direction.

 

Brent: Yeah exactly.

Phil: So the market's up roughly 14% year to date. We are raising our price target today to 4,500. That's up about 4% from Monday's close. You say, well, that's not much. Well, remember, we just did 14% 6 months. So, if over the next 12, we do four, the 18-month period looks pretty good. We also are increasing our bear and bull case. Our bear case is now 3,400. That's down roughly 20% from Monday's close, and the bull case at 5,150 raised that as well up about 19%.

Brent: Yeah, I think the one thing that's certain feels that along the way over the next 12 months. I think the one thing that both you and I believe will be certain is an awful lot of volatility along the way.

Phil: So, yeah, we are not believers that you set a price to our and you just assume you're gonna march there very cleanly. Right? Chances are we can have some down markets and some up markets, and we end up somewhere around 4,500. So, what are the details of the forecast? In the bear case, we have a downward next 12-month EPS revision, earnings per share of revision.

Brent: Yeah. And continue to fall further.

Phil: Exactly. Followed by below average earnings growth in months 13 to 24. Why do we look at months 13 to 24? Well, the reason is in 12 months, you're looking ahead to 12 months. Right? So months 13 to 24, and price-to-earnings contraction. That valuation we showed you contracts. In the base case, modest earnings downward revision, followed by average earnings growth from months, 13 to 24% or 7.5% with slight multiple contraction. So, still a pretty expensive market but slight contraction. In the bold case, this is Goldilocks. This is what we all cheer for. This is positive earnings revisions fall by slightly above average earnings growth. Two years out, and slight multiple expansion.

Brent: Yeah. Yeah. So one of the things that we had talked about last time was where we are in the cycle as it relates to monetary policy and Fed rate hikes, and what that might portend for stocks in the future. And what we wanted to look at is the hiking cycles, you know, post the early 80s going forward. So what you're looking at here is all of those cycles post-1982. And you can kind of see what happened, that that dotted line, that vertical line, is the final Fed rate hike and what the S&P 500 did 12 months post. And you could see the dark line that cuts through all of that is the average of all those cycles. So on average, after the final fed rate hike, the S&P 500 12 months later produced a positive result, and you can see almost double digits on average. And what you can see, a lot of variability there, Phil. The gold line right, is the 2000 cycle. Right? What happened there? In May of 2000, basically, was that final Fed rate hike in December of that same year, they ended up starting to cut rates. So again, that one point in time historically where you ended the hiking cycle and then had to cut immediately because of what was going on in the economy, caused the S&P 500 or there was many factors that caused it. Was one of the contributing factors as to why the S&P 500 didn't. So again, probably, we believe, knock on wood, but the Fed states it keeps rates higher for longer and doesn't turn around a cut, you know, a couple months after the last few days.

Phil: And look, if they're cutting quickly, it probably means something broke [UNINTELLIGIBLE]. So the hope is they're able to exceed the fire of inflation.

Brent: Yeah. And speaking of recession, this was a note that we put out on the next slide, Amy, a little while ago. I think it's really important. I think, you know, you know, tearing this out of this presentation, hanging up on your wall to remind yourself of why you really need to be a long-term investor. What we're looking at here, Phil, is, you know, all 12 recessions post-World War II, and you can see on average, the recession lasted about 10 months. And, you know, what did the S&P 500 do during a recession? And you can see, 50% of the time it was positive, 50% of the time it was negative. When you look at the observations that were negative, median observation basically more flattish. When it was positive 50% of the time, you can see both average and median were significant double digits. But what I would say, Phil, is way more important, you know, versus what happens during the recession for stocks, it's what do stocks do, 1, 3, 5 and 10 years post recessions. And you can see and look at that percent positive on the graph, 92%, 100, 100 and 100% of the time, 1, 3, 5 and 10 years post a recession, stocks were cumulatively positive. And if you look at that average and median number along the way in that 1, 3, 5 and 10 years, not a lot of skew, right? So you had very consistent positive returns on a cumulative basis after recessions. So again, if you're an intermediate to long-term investor—which we hope all of our clients are, regardless of whether we enter a recession or not, regardless of what happens to stocks during that recession—the longer-term implications of what stocks do, after a period of time like a recession, is broadly positive, at least from a historical perspective.

So let's shift gears away from stocksville, and let's talk about the fixed-income environment. When we look at where yields are today, which is that far righthand column, yields, and what we're looking at here is yield to worst—which is nothing more than the yield to maturity adjusted for some of the optionality in the bonds, call, features, and provisions, et cetera—you can see the column on the right, yields are significantly higher than where we were at the end of 2021. And as we've talked about a lot in the past, Phil, current spot yields tend to be a very good predictor of forward expected returns for fixed income over the duration of the horizon of that individual benchmark. And as you run your eye down that list, you can see some very, very large numbers, whether you look at aggregate bonds at 4.7%. Look at municipal bonds at 3.51% nominally. If I adjust that for the highest tax bracket and put in the additional 3.8% Medicare surcharge, you're looking at municipal bonds on a tax adjusted basis of almost 6%. So across the board, bonds are an attractive component in a portfolio today versus where we were back in 2021.

One of the slides that we put this out in in a note that that you and our fixed-income team put together—it was a great note if you haven't read it—what we're looking at here is how yields move relative to that Fed hiking and cutting cycle. The gold line is the Fed funds rate, and the other lines are the yield on the 3-year and 5-year treasury. And I'm gonna highlight the black circles around the Fed, you know, ending of a hiking cycle and the beginning of their cutting cycle. And what you can see is that once we paused rates, you can see the lines underneath, there's a lot of variability in yields. But once the Fed started cutting rates and yields fell, right, you had a very consistent downward movement in yields, which means yields down, prices up. Right? So again, a lot of volatility, but we believe that as we talked about earlier, we're getting closer to the end of a hiking cycle. Time will tell when that is. We think that we're gonna keep rates longer, right, just like the 2006 period where you know, last hike was in July of 2006. We didn't start cutting rates until September of 2007. Almost 15 of staying at 5 and a quarter percent. We'll see what happens this time. But on the next slide, Amy, when we think about the questions a lot of our clients are asking is, you know, cash or duration, longer duration, whether that's cash or intermediate or cash or longer-term bonds, one of the things that you have to take into consideration is total return, and what we're showing you here is gold bar is 3-month treasury bill index. The gray bars is the 1- to 10-year treasury index. So think more intermediate term. What happened from a total return perspective in each one of those cycles, post the last Fed rate hike. And you can see while it's attractive to have cash yielding north of 5% today, when you're looking at total return towards the end of that last fed rate hike, total return, intermediate to longer, has outperformed cash. So having a balance between cash and longer-term bonds in a portfolio, we think is the right strategy here.

Phil: Look, with the inverted yield curve, it's hard to go further out on the curve and buy longer duration fixed income. They might be yielding less than short duration.

Brent: Right. Right.

Phil: But you're locking in. You're locking in for that number of years, and from a total return perspective, when rates do fall, as we showed in the previous slide, and on this slide, the total return goes up.

Amy: Brent and Phil, thank you so much for all of that information. If you're joining us for the first time today, thank you for being with us. We present this information every single month. I do also wanna invite you to subscribe to our content to be delivered directly to your inbox on a regular basis. So written commentaries, periodic videos, answering questions that we're hearing most often from clients, a weekly, weekly economic update from Phil—all of that is available on our subscription. If you would like to receive that, I would encourage you to hit the QR code and get signed up. If you're using your phone, you can visit firstcitizens.com/wealth to get signed up.

Brent, Phil, we do have a number of questions that were submitted into our registration process. By the way, if you'd like to submit a question, please do so using the registration. We monitor that throughout the month to make sure that we're answering your questions and delivering that through our regular content. So Brent, let's jump right in. No surprise here. Got a couple of questions on the situation in Russia. What's your take on geopolitical risk and your view of the current events?

Brent: Yeah, it's certainly an interesting event with the Wagner group and what's happening not only in Ukraine but within Russia. You know, certainly, a lot of uncertainty as it relates to geopolitical events. I think most importantly, if I translate those geopolitical events, let's say, to what we care about, which is the economy and markets, at least from a market perspective historically, I think we've highlighted this in a couple of our written pieces. Geopolitical risks and uncertainty has been prevalent throughout the dawn of time. And if I go back, you know, over the last x number of events, there's been a myriad of geopolitical events and turmoil as it relates to markets. They tend to have a short-lived and modest impact on equity markets. And when you fast forward 12 months from those geopolitical events, markets tend to look past that short-term news and look towards more economic data and fundamentals. So again, while there's a lot of uncertainty with the events in Russia, and it is certainly a big event, at least from a market perspective and an economic perspective, so far, the markets have taken it in stride, Amy.

Amy: Thanks, Brent. Phil, unsurprisingly, some people were beginning to question where our price target was for this year. What's your view for the stock market and the reasoning behind our updated price target?

Phil: Yeah. Absolutely. If we flip to slide 24 just for a visual. So look, I won't dwell because we talked quite a bit about it, but our price target's 4,500. I think, you know, and you think about this as a framework, look at it as a whole though, there's bear, base and bull. So, if you think we're too conservative, well, there is data behind why we picked that full case. Right? But generally, I describe us as, look, we've done 14% this year. We are up a lot. It's not a cheap market. We are still optimistic. Even if we do have a recession, you show that half of recessionary periods, the market's actually up. We do see the market priced a lot of bad news last year. But that 4,500 is unlikely to get there in a very smooth stair-step manner. What's more likely is, the market's pricing a lot of good news, we have some disappointment, some volatility call it in the next couple quarters, but we end up something like 4% from today in our view. Now the caveat is always price start is hard to communicate our general sense of things, not to take literally as a point in time estimate.

Brent: That's right.

Phil: Right? If we knew exactly where the market was gonna be in 12 months, that would be amazing.

Brent: Yeah, we'd be on a beach in France or something.

Phil: Yeah, but we and no one else does, but this is just to really communicate our framework. And where we're thinking in terms of our base case and where the bear and bull could play out.

Brent: Yeah. And I think it was important when you highlighted, Phil. We last updated our price target in December of last year. Yep. Right? And we'd call for 4,100, which was, you know, a 7% move from where the market was at the time. We got the directional vector right. Right? And, you know, we're updating it based on the confluence of data and what we see. So again, a broad trajectory, not really designed to be that precise number looking out 12 inches wide.

Amy: Phil, this person is asking how should I think about income investments giving this rate environment?

Phil: Yeah. It's a great question. And Brent, we dug in on this a lot. One, definitely recommend the note we put together. If we turn to slide 28—and just kind of use this as a visual—one, fixed income is attractive, right? We showed the yield differential where we are today versus to 2021. So and we're seeing that from clients. So far more attractive than where we were. But what type of fixed income, right? And right now, it's very tempting to just say I'm only gonna hold short-term fixed income because I'm getting a lot of yield. The risk is, as you can see in past cycles is, while the Fed may be on hold for a while, eventually they cut.

Brent: Yeah.

Phil: And the truth is, often the Fed funds rate is above the 3- and 5-year treasury during the, look at those circles. You can see within those circles, there are periods where the 3 and 5 year are below the Fed funds rate, just like today. But if you bought those fixed-income products, longer duration, you locked in. And you were able to have that return for 3 and 5 years just as money market rates were falling. So we do think there is real opportunity to extend duration. It does not mean you go crazy, but there is opportunity. And then as we—I won't dwell on it—but the next slide, we did point out, even from a total return perspective it pays, because as those rates start to fall at some point, total return goes up.

Brent: Yeah, and I think it's incredibly important from a portfolio construction perspective, Phil, to keep your financial planning goals and objectives in check and making sure that you have balance, and you consult with your adviser to make sure that you have the right confluence of short-term liquidity and cash to make sure that your plans and check, as well as having thoughtful diversified fixed income in your portfolio. But as you said, forward opportunity for fixed income, we haven't been here in a long time, and we think the future is bright. Longer term for fixed income given the starting point that we're at today.

Amy: And Phil, staying in the rate environment, when it's on a broader global view, how is inflation in Europe and elsewhere being impacted? I know the Bank of England was in the news recently. Will our monetary policy be affected by those decisions over the next few months? Is the risk of deflation a factor?

Phil: Great. So it's a great question. One, inflation right now is a global phenomenon, particularly within developed markets. It's not just US specific. It is a reminder that we did have a pandemic that impacted the globe. It's not just specific monetary or fiscal policy in various parts of the world. Truth is, Europe has a bit more of an inflation problem today than we do. Right? Eurozone's at 6.1%. The United Kingdom's at 8.7% year on year for CPI.

Brent: That's high. That's high.

Phil: Very high. We're at four. In terms of impacting our monetary policy, the truth is we're the leader in the clubhouse. Right? We have done a lot of hikes, likely gonna do one or two more, but I don't think I think if anything we're impacting them, not the other way around. We're the largest economy in the world. So I don't expect that. Sometimes, there is a little bit of belief that monetary policy is driven by FX, by foreign exchange. It is one of the reasons we had a lot of dollar strength last year because we were hiking before our counterparts. I don't I think the Fed is focused on US inflation. The truth is, it's higher elsewhere. That's the focus. I don't think that another central bank is going to dictate what we do. From risk of deflation, it's funny because really, pre-pandemic, it was something we talked a lot about. Inflation was so low, Brent, we were in a very disinflationary market. There was a reason there was unbelievable monetary fiscal stimulus after the financial crisis because the concern was deflation.

Brent: Absolutely. And something that maybe we'll look to cover in a future WebEx is when you think about the relationship between M2 money supply, either growth or contraction, you know, inflation tends to move relatively similar to that, but on about a 16-month lag. Right? We've seen a significant contraction in M2 money supply. So again, time will certainly tell. I think inflation as we highlighted nicely is moving in the right direction, and then we're getting into spitting distance to the Fed's, you know, 2% target sometime, maybe in 2024 but ultimately, probably more like a 2025, I think if at all, but again, the directional vector is moving in the right area.

Amy: Phil, all the questions are for you today. Sorry.

Brent: Hey, that's good.

Amy: When we enter the next easing cycle, what probability do you ascribe to inflation coming back higher? A violent move higher or a more graceful move?

Phil: Yeah. So one, I think this is why we've had the view that the Fed would not be quick to cut They do not want to see inflation come down, then to cut rates just to see it go back up, right? If they fall through with what they're saying, which is stay higher for longer, I think just because they ease, let's say because of an economic slowdown, does not necessarily mean inflation just immediately comes back. In fact, we had incredibly easy monetary policy, as you can see, in this 2012 through 2020 timeframe, and inflation was very low. In fact, we were worried about deflation for some of these periods. CPI turned negative at points even. So just because you have easy monetary policy does not mean inflation just happens. It doesn't work that way. The truth is, are they easy monetary policy because the economy is slowing? And if the economy is slowing, that's disinflationary. So look, they're gonna stay hawkish for a while. They do not wanna see inflation come back when they start cutting, but I would not assume just because they cut inflation comes back probably cutting for a reason that is disinflationary.

Brent: Yeah. I mean, look, the Fed are very good students of history. They've seen it where we were in an environment in the late 70s and early 80s where you got a lot more variability to inflation kind of cycling, kind of going down and coming back up. And I think, you know, that that's all the reasons that you were spot on as you as it relates to the Fed keeping rates higher for much longer until they really feel that inflation is undercooked.

Phil: And I think it is worth pointing out that they were late to the game. Right? In hindsight, they should have started hiking sooner, But I don't think there's been a shift in the policy philosophy. Right? It's the same philosophy we've had for a few decades now, which is they're not going to let in inflation be the tail of the wags the dog.

Brent: Correct.

Amy: Well, Brent, Phil, thank you so much as always for answering questions and providing all of that deep analysis on what's happening in the markets and the economy. On behalf of all of us here First Citizens, thank you for joining us and trusting us to bring you this information. That's something that we never take for granted. We hope you found this information helpful, and we'll be sharing information about July's market update in the coming days. Be sure to sign up and submit your questions for Brent and Phil, and we'll be watching those throughout the month. Thanks, everyone.

Making Sense In Brief Outro Slide

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.