Making Sense: May Market Update

Amy: Hello everyone, and welcome to the First Citizens Wealth Management Webinar series, Making Sense, where Chief Investment Officer, Brent Ciliano, and Director of Market and Economic Research, Phil Neuhart help you make sense of what's going on in the markets and the economy.

I'm Amy Thomas. I'm a strategist here at First Citizens Bank and before I turn it over to Brent and Phil, we do have a couple of housekeeping items to get through. First, this webinar is being recorded, and a replay will automatically be sent to you following today's conference. Secondly, this webinar is interactive. If you'd like to ask a question, please use the Q&A or the chat feature on the right-hand side of your screen. All questions are confidential and only visible to myself and the panelists.

I do want to remind you we try to keep our discussion broad. 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, Phil, with that we're ready to go, so I'll turn it over to you.

Brent: Great. Well, thank you, Amy, and good afternoon, everyone. Hope all of you are well. Amy, I wanted to extend a very special welcome to our Silicon Valley Bank clients and new colleagues—a warm welcome. Hope you subscribe and, and, join our calls in the future. Phil, an awful lot to talk about today. It seems as we get later in the year, we pack more and more into these presentations.

Phil: Absolutely.

Brent: So on the economic side, we're gonna cover the big three. We're gonna talk about the trajectory for economic growth in the United States and the probability of recession, Phil. We'll talk about the path of interest rates and fed monetary policy. We'll talk about inflation and where we are and where we go from there.

Then we're gonna talk a little bit about the consumer, consumer spending and what that actually looks like. But we get a lot of questions Phil, about residential and commercial real estate, so we're gonna hit that this time around. Then we'll shift gears. We'll talk about, where do markets go from here in both equities and fixed income? We'll talk about a lot of the shorter-term issues, Phil, that are affecting the markets, think debt ceiling, monetary policy, geopolitical.

Certainly, gonna hit them, but we'll take a huge step back and talk about big picture, what does it look like for stocks and bonds and the few, forward viewpoints? So, with that, Amy, why don't we jump right in?

So, let's talk about economic growth, and let's talk about where we specifically are. Coming into the year, Phil, expectations for growth globally and the US, relatively sanguine, 2.1 for global. 0.4% for the United States. To put that into perspective, the 50-year average for the world is about 3% for the United States. About 2.73. So, definitely subdued growth expectations coming into the year. Sitting here in May, expectations and the broad mix of data has gotten modestly better, but by and large, Phil, we've seen sort of a recent mixed bag as it relates to the broad swath of economic data points.

Phil: That's right. Our recession probability remains 60% over the next 12 months. We've been there for a couple quarters. Think about manufacturing activity—

Brent: Yeah—

Phil: —it is slowing down. Even as the consumer is hanging in there okay. There's some momentum we'll talk about that might be turning down. And even the labor market is, is, potentially softening. So, it's hard to imagine the Fed doing what they've done in terms of going from near zero to over 5% Fed Funds Rate and there not being consequences on the economic side. We think we maybe are seeing some early signs of that for sure.

Brent: Absolutely. Absolutely. So, let's talk right about that. Let's go to the next slide, Amy. Let's talk about the path of monetary policy. And, Phil and I wanted to put the slide into the presentation deck this time around just to show you the magnitude and speed to which monetary policy, this time around, has really come into bear. So, what we're looking at, the gold line is this most recent cycle. But Phil, we're looking at every tightening cycle post 1983. So, you can see clearly, the most compact, highest moves that we've seen and broadly, as you've said many times, that monetary policy acts on long and variable lag, so, the extent to which that's flowed through into our economy likely has yet to be seen.

Phil: That's right. We're just seeing the early stages of that flowing into the economy.

Brent: Absolutely. So, let's go to the next slide, Amy. Let's talk about what market participants are looking at as it relates to the path of rates from here. And again, this is market implied pricing pit, Phil, from Fed Fund futures. Gold bar is Fed funds expectations back before we had some of the, the issues within the banking sector back on March 8th, that's the gold bar and you can see, expectations were for much higher path of rates from where we are today. The gray bars is really Phil, where we wanna center on, which is where we are today. And you can see the path of rates, and we've got a FOMC meeting coming up in a couple weeks on June 14th, expectations are relatively benign that we've seen the high-end rates broadly, small probability of an increase at the next meeting, but by and large expectations are for the second half of the year that we might actually start to see some cuts in rates, and as we get into the first quarter, second, first half of next year. From our perspective, we believe that the Fed didn't do all this work, inflation's still a little persistent and sticky, still high, relatively speaking. So we think the Fed’s not going to unwind all of that work here in this year and that we don't see rate cuts until at least the first quarter, if not the first half of next year at the earliest.

Phil: Absolutely. So, when you think about rates and inflation as we flip ahead, they're really, they're linked. Right?

Brent: Right.

Phil: So, when you look at past hiking cycles, and the horizontal axis here is showing the end of past hiking cycles all the way back to the 1970s. What you'll notice was when the Fed stops hiking, you never see the Fed, the Fed funds rate is always above the rate of CPI.

Brent: That's right.

Phil: It's always above the rate of inflation. That was, we showed this chart for many months, that was not the case.

Brent: That's right.

Phil: Right? Until this month.

Brent: Yeah, we're waiting for that to shift.

Phil: Yeah, that's right. So, it is now shifted. The Fed fund’s rate is at 5.25%, at the top end of their range. CPI is at 4.9% as you mentioned, we have a meeting coming up on June 14th and the next CPI is the day before that rate decision on June 13th.

Brent: How apropos, right?

Phil: So, we'll see how things shift, but when you hear people like us say, we think the Fed can pause here, well, this is one of the reasons why—

Brent: That's right.

Phil:—is that the Fed Funds Rate is finally above the rate of CPI. So, it's been a long way to get here. We still have work to do, but this is important to see. And speaking to that path on the next slide, the path of CPI, the gold line here. Inflation peaked at 9.1% last summer.

Brent: Yeah. Crazy—

Phil: It's fallen for ten consecutive months, which is important. If you had asked me, would we move down in a straight line? Like, I would say, probably not.

Brent: Right.

Phil: So, in some ways, it's a positive when you think about the fact that the market bottomed last October. I mean, this is one of the reasons why. What you will notice is that it's nowhere near 2%.

Brent: That's right.

Phil: So, saying that the rate of inflation is slowing is not saying there's deflation.

Brent: That's right.

Phil: Those are two very different things and something that our clients need to remember. We have a lot of work to do. I think you could argue that going from 9.1 to 4.9 might be easier than going from 4.9 to 2.

Brent: That's right.

Phil: Right? There’s still work to do—

Brent: So the velocity inflation falling from here might start to moderate because of that.

Phil: And I think that's a reasonable expectation. And honestly, I think a lot more participants almost expect that. So, core inflation, that excludes food and energy.

Brent: That's the gray line.

Phil: That's the grey line. And what's interesting is, one, core inflation, ex food and energy, never got to the level of headline that peak. But it now exceeds headline. And it has exceeded it for the last two months. So, we talk about some stickier inflation, as you mentioned a moment ago, this is what we're talking about. Something to watch, the Fed is very focused on core inflation.

Brent: Right. And it might be one of the reasons why they, they stay higher for longer until we start to see that velocity come down from a core inflation perspective whether that's owner equivalent rents or primary rent.

Phil: And we've, we've heard some recent hawkish comments from Fed officials, they're trying to get that out into the marketplace—

Brent: That's right.

Phil: That hey, guys, we're serious.

Brent: Yep.

Phil: So, as we look ahead to inflation expectations, what are we showing on this next slide? This is consensus estimates in the gold bar. So, what is consensus here? Consensus is bottom-up Wall Street economic estimates, right?

Brent: Yeah.

Phil: So, these are model driven. Does not mean they're always right. This is not, for example, an opinion poll of people on the street. These are experts trying to figure out where inflation is going. They've not changed too much this year. In fact, what we do see is a moderate slide down in terms of inflation expectations. Down to 2.6% second quarter of next year. What you'll notice is that's not 2%.

Brent: Exactly.

Phil: Right, the Fed's target's two. We are consistently asked, when does inflation get to two? We answer maybe not for a very long time.

Brent: Yep. Yeah. One of the more variable parts that could throw a monkey wrench into this, in, in a positive sense, positive sadistically for—

Phil: Right.

Brent: —the path of inflation is if we were to have a recession, one of the easiest ways to bring prices down is, is to have a recession to where that velocity might fall further. Again, don't want that to happen. We hope it doesn't happen, but that could radically affect the path that we could—

Phil: Which feeds right into our 60% recession probability. Usually when the Fed has a major hiking cycle, there's a recession associated with that and the reason is, you're trying to get inflation down.

Brent: That's right.

Phil: So that's what, these are all linked. So, what else is tightening financial conditions as we turn to the next slide? We've seen bank lending contract.

Brent: Yeah.

Phil: So, this is directly related to the events of March in terms of concerns within the banking sector. When you look at commercial banks, loan and leases, they're two-week change. The two-week change at the end of March, that, that circled area there, was a multidecade event, I believe 50 years in fact, in terms of contraction. So, you've heard the Fed mention this, this is equivalent to some number of rate hikes. We can't argue with how many, but this is equivalent to tightening financial conditions through interest rate hikes. It just happens to be on the lending side. This is how it works, right? You get the Fed hiking, you see tightening lending standards elsewhere, which are equivalent to hikes.

Brent: That's right.

Phil: And, and that's how you get inflation down eventually.

Brent: So why don't we take that a little bit further and we talk about the labor market here on the next slide, Amy? So, I mean, we have talked about for countless WebEx's, Phil, that the labor market has been tight. Right? The unemployment rate today sits at 3.4%, which is the lowest level in more than 50 years. So make no mistake, the labor market is tight and still remains tight. But what we're seeing here on the slide is initial jobless claims and if you think about where we were back in October of last year, we've seen jobless claims start to rise. Right? Now, again, we're coming off of a very low base. And from an historical perspective, it's still low, but we're starting to see that start to loosen up just a little bit. Right? So, again, we're not prognosticating that this is the beginning, and we're gonna see the unemployment rate jump a percent but by and large, we're starting to see claims start to creep up and something that you and I are definitely gonna be watching.

Phil: And the truth is much of what we're seeing in terms of loosening the labor market. The truth is, if we're being honest, we would have expected to see it sooner—

Brent: Absolutely.

Phil: Considering how aggressive the Fed has been, but starting to feed in finally.

Brent: Yeah. And on the next slide, Amy, when we look ahead and we look at the chart on the left, and we look at the total number of job openings. I mean, look what it came down from, Phil. We've talked about this before. You know, 12 million open jobs, which is the highest level that we've ever seen, now down to 9.6. So, the directional vector is down. But again, if you drew a regression line through that data, we're significantly above the long-term averages that relates to job openings in the United States. And then when you look at the chart on the right and we take a look at job openings per unemployed folks, you can see that we've come down significantly from almost two open jobs per unemployed person to about 1.64, moderating lower. But again, draw a line through that data and we're significantly above the long-term average. So again, job market's still tight but loosening at the margin. The most important thing on the next slide, Amy, if we can advance, is consumer spending. Right? We talked about this last time. When I think about the consumer, the US consumer explains more than 72% of US real GDP. You've got 69% is from consumption, another 4.7% is from housing. So as goes the consumer, Phil, as goes our economy. And when you look at the chart on the left and we look at personal consumption expenditures, the gold line is spending on goods. The gray line is spending on services. And what you can see with that little callout box, good spending has moderated below that 20-year average, still decent. Right? But moderating below. So, again, back when we were, you know, buying everything from Amazon and we were tripping over our boxes on our front porch, post-pandemic moderated more towards services, and that's why we can continue to see the service sector doing well in services inflation being as sticky and persistent as it is, because look where spending is as it relates to consumer expenditures.

We brought in a new chart this time around on the right here, which is the Visa US spending momentum index. And what we're trying to gauge from this index, it basically looks at spending on credit cards and debit cards across both services and goods—online brick and mortar—to get basically the velocity or momentum of consumer spending. Above 100 basically means that that momentum is accelerating, right, i.e., spending is accelerating. Below 100 basically means that momentum is decelerating. And what you can see from the highs that we saw in 2021 that momentum has been decelerating. We've now broken through that, that hundred level, which basically means broadly across goods and services that the consumer might be getting a little tired and might be spending a little bit less.

Phil: Look, inflation's taking its toll. We've seen that in things like credit card usage. Sorry, the consumer has hung in there because the labor market's been tight, but momentum slowing starts to make some sense when you think about the macro environment. So, let's talk about the housing market. So, there's a lot of interesting things happening within the housing market, and, and some of it is subtle. Right? So, let's talk about the big picture and then we'll talk about the charts. In sum, the housing market's slowing. Right? We had mortgage rates skyrocket, we had home prices skyrocket, that hurt affordability. Right? That has impacted everything from home sales to prices. What's interesting is supply remains tight.

Brent: Yes.

Phil: And that is the interesting component that you've not necessarily seen in past cycles.

Brent: Yep.

Phil: And it is driving the markets. Let's talk about the facts. On this slide, on the left side, you can see year-on-year price appreciation, this is the Case Shiller index nationally. You can see the year-on-year number, this gold line on the left side is still above zero, but it has fallen precipitously, right, from 20 to low single digits, but still positive. Now some of the month-on-month are seeing negative.

Brent: That's right.

Phil: We should admit that, but what's interesting is you are not seeing that severe negative you saw, for example, during the financial crisis can see there in '07 to '09. The other thing we should point out is the median sales price is still very elevated.

Brent: That's right.

Phil: Look at where you are in that gray line. Yes, there's been a tick down, but in general you were way above the pre-pandemic levels. And so even though there's been moderation in price appreciation—

Brent: That's right.

Phil: Home prices, the median sales price has remained elevated.

Brent: That's right. Yeah. When you sit there and you're sitting there with a mortgage at, you know, 3% or somewhere around there and you have mortgage rates at 7%, you might be a little bit more reluctant to wanna move out of your home. Right?

Phil: And to speak to that point supply on the right side. This is months' supply of homes. So how many months does it take to, if you flip back, Amy, how many months does it take to work through the inventory of homes? And what you'll notice here is it's still very low.

Brent: That's right.

Phil: It's come up, right? Month's supply is ticked up from the lows of 2022, but very low by any historical period over the last 20 years. What does that mean? That means, the housing market's tight. We are also hearing this on the road. Antidotally, we spend a lot of time in front of clients. Housing market's tight. It's slowing, but tight.

Brent: And regional, right? We know this is, again, national, so regional definitely varies.

Phil: That's right, so when you put all of this together on the next slide, home sales have fallen precipitously, you can see on the left there. Again, if you have that mortgage locked in, you're hesitant to put your home on the market. Well, if the home's not on the market, it's not there to sell.

Brent: That's right.

Phil: Not to mention the things with affordability we mentioned. So, home sales have fallen well below pre-pandemic levels. What is interesting though, is housing starts. New construction on the right side has fallen, as you'd expect, but it's basically at or above the pre-pandemic levels. Why is that? Supply is tight. So, it's very interesting. Look at what housing starts did in the '07 to '09 into 2010 period. It fell precipitously. We've seen a decline, and we may still be in the early innings here. But so far housing starts have hung in there. That supports the economy.

Brent: Absolutely. And hopefully that little fishhook on the left is a bottoming process that we don't see another leg down in existing home sales or getting—

Phil: Fingers crossed. Really important for GDP. So, the other side of this coin is commercial real estate on the next slide. And that has been much more severe of a downturn when you look at prices. So, this is a broad index down negative 15% at commercial real estate year on year. Think about the single digits and residential—

Brent: That's right.

Phil: Negative 15. Now with commercial real estate, the caveat is always, one, it is very regional. Very metro to metro.

Brent: Absolutely.

Phil: It can be different urban to suburban in the same metro. Also, it can look very different between office versus apartment, apartment versus retail. So again, it really depends on your market, but nationally, you are seeing a slowdown in commercial real estate. This has contributed to some of the concerns within the regional banking sector.

Brent: That's right.

Phil: This is a risk. It is a known risk. I don't know the last presentation I gave that this was not brought up.

Brent: That's right.

Phil: But it is a risk nonetheless, something we have to consider and something the marketplace has to consider.

Brent: Yeah, absolutely. So let's do this. Let, let's shift gears, Amy, and let, let's talk about the markets, Phil. And I know that we're gonna talk a lot about, a lot of short-term factors that are affecting markets. We're gonna talk about debt ceiling. We're gonna talk about monetary policy. We're gonna talk about geopolitical risks. We're gonna talk about all that. But I wanted our listeners to take a huge step back, huge step back, and look at the relationship, the long-term relationship, between stocks and bonds as diversifying assets in a portfolio. What you're looking at on this chart is 100 years of performance information between stocks and bonds. On the vertical axis, we have the S&P 500. On the horizontal axis, we have intermediate US government bonds. Right? And above the line, is positive stock returns, below the line, negative. Right? To the right, we have positive returns for bonds. And to the left, we have negative returns for bonds. What I want all the listeners to focus on, Phil, is that bottom lefthand quadrant. That's when both stocks and bonds have not worked together, i.e., both of them produced a negative result in a calendar year. So, I wanna pause on that and look at that bottom lefthand quadrant. Out of 95 observations that are on this chart, right? Only four of 95 times have we had stocks and bonds produce a negative result together. Right? And the one thing when you look at the dates that are there, notice that none of them are next to each other. We don't have consecutive years.

Phil: Right.

Brent: And roughly, you've got about 30 years between each one of those events. So, Phil, I'm knocking on wood that the next time that we have another bottom lefthand quadrant event, it's 30 years from now, and that'll make me 100. No. It's something like that.

I'll be older. But by and large, you can see that they've been great diversifying assets across the board. On the next slide, Amy, what the one thing I wanna focus on, we're gonna start with income this, this month. Right. We, we had a bad year. Actually, the worst year ever for fixed income occurred last year. And when you look at this chart, we're looking at the Bloomberg Aggregate Bond Index, which is a broad index of government and corporate bonds in the United States. And what you can see is in 2022, we had a drawdown of about 13% intra-year. It was about negative 17%, which is the largest drawdown in history. If I took this and swapped this out for, let's say, government bonds so I could take the data series back—

Phil: Right.

Brent: If I go back 250 years, Phil, 250 years, we've only had five observations where we've had 2 consecutive years of a drawdown. So, look at what happened in the last 2 years. Negative year in 2021, negative year in 2022. It's only happened five times in 250 years. We have never in 250 years of data had 3 consecutive years of negative returns and fixed income. So again, I'm knocking on wood that this year for fixed income produces a positive result. If it doesn't, it would be the first time in 250 years that that occurs. So why don't we move forward?

Phil: Yeah.

Brent: I'm gonna talk a little bit about the—

Phil: Let's just talk about the level of yields versus total, total return. So here we're showing what were yields of various fixed-income asset classes at the end of 2021 versus essentially today. Let's just say the last 18 months. And what you'll notice is even with some of these yields coming down, for example, the 10-year peaked last October and it has come down. Yields are far higher, so 10-year treasury, for example, over two times the yield.

Brent: Yeah.

Phil: And what we're hearing in the marketplace, certainly from our client, is, is demand for fixed income.

Brent: That's right.

Phil: Right? We see that every day. And the reason is there is finally yield. Even if it's lower than it was maybe a month or two ago—

Brent: That's right.

Phil: Doesn't matter. The truth is you're finally getting paid to own fixed income.

Brent: Yeah. And I think what's really important when you focus on the column on the right, that, that, that's yield to worst. In essence, right, your yields of maturity adjusting for optionality, right? So so, when I look at the aggregate bond index at almost 4.6%, that is your forward expected return or a good proxy for your forward expected return over the period of the duration of that index, which is roughly about 6.8 years. So, across the board, yields are much higher. The one thing I did wanna point out, because we're gonna be talking about the debt ceiling and some of the volatility that's going on in the fixed-income market, when we look just specifically at the treasury yield curve, we do believe that from the belly out, so let's think 5 years out to 30 years, that we do believe that the highs are in. Right? So, we hit 4.24% on the 10-year treasury back on October 24 of last year. We think that that's potentially the high. There's certainly gonna be volatility. We've seen a lot of volatility in, in the 10 year. But on the very short end of the curve, we still have debt ceiling. We still have monetary policy that we have to deal with. We have sticky inflation. I don't wanna basically put it out there that we've seen the highs on the very short end of the curve. We might have been there, but time will tell. So maybe when you think about forward expected returns, Phil, what do you think?

Phil: Yeah. So one thing we've been saying to clients for some time now, for a matter of months, even quarters, is it, is not a bad idea to think about extending duration if it fits your needs. In other words, buying longer-term fixed income. The reason is, yes, the yield curve is inverted. Short term yields are above long-term yields. But if you buy that longer-term yield, you are locking in—

Brent: That's right—

Phil: Versus short term yields, which can move very materially. We were reminded of that just over the last year.

Brent: Absolutely.

Phil: So it is an opportunity to lock in some longer-term yields, something we are encouraging clients, always specific to their circumstances, to do.

Brent: Yeah. Based on your financial plan and needs, it's good to have both. But for the intermediate to long-term investor, instead of, you know, rolling down the curve as yields start to fall, maybe next year or beyond, locking in some of those more preferential yields for a longer period of time will be good for total returns.

Phil: Absolutely. So, sticking with the theme of fixed income on the next slide, what we're looking at here is called option-adjusted spread. This is investment grade. These are investments—

Brent: Sounds complicated.

Phil: Yeah, it's really not. It is investment-grade bonds, is what we're focusing on here. It's just what is the premium the market is demanding to buy a corporate bond over a treasury, over a risk-free asset. So, what you'll notice is when this number goes up, it means higher risk in the marketplace.

Brent: Yeah.

Phil: So, 2020, when things looked really ugly there for a while, you saw a spike in spreads. What's interesting, since March, some of the dislocations in the banking sector, spreads have risen, but have not even risen to the level of last October.

Brent: Yeah.

Phil: So when you think broadly across investment grade, the market's not all that concerned. Doesn't mean the market's always right. But fixed-income markets are not blowing out in terms of spreads. One thing to point out is financial spreads have bifurcated from non-financial.

Brent: That's right.

Phil: So, we look at the financial sector, spreads are rising, non-financial, not as much. So what is pulling this spread higher recently is the financial sector, which makes some sense.

Brent: Yeah, absolutely. To your point, when you adjust that X financials, you're more about that 135, 140, right? So, you even have, you know, a more benign, you know, spread widening as it relates to investment grade bonds for sure.

Phil: So Brent, that's fixed income. What about the stock?

Brent: Yeah. Let's talk about the stock market, right? So, you know, we talked about this on a number of WebExes, right? We saw the low, Phil, back on October 12 of last year, about 3,577, on the S&P 500. From that low back on October 12, we're up, we'll call it 17%. If I just wanna focus year to date, we're up, geez, looking at about 7% right now.

Phil: Right.

Brent: It has been a very, very narrow range, a very narrow breadth of stocks that have driven that. When you look at the callout box here that we've highlighted, 10 stocks have accounted for more than 80% of the S&P 500's total returns year to date, which is at the highest level in more than 30 years. Right? And when I think about it even more broadly, and I think about the number of stocks that are above their 200-day moving average, we're still sitting at just barely north of 50%. Usually, when we have a more sustained bull market rally versus a bear market rally, you tend to see that breath upwards in the 80, 90% above their 200-day moving average. So again, very, very narrow rally, very driven by a lot of larger technology names.

So on the next slide, Amy, let's kind of bifurcate that conversation a little bit further, and let's look at what's worked and what hasn't year to date. You can see across the board, growth stocks, Phil have, have worked really well. It's more on the higher quality, growth stocks. Right? So, think big, mega tech, right, I would say more value valuation rich companies have done really, really well. But again, remember, a lot of those companies let's just take a sector like technology, which had sold off a lot, is up, what, 25% year to date, you know, some other sectors—

Phil: Services is up 30.

Brent: Exactly. Right? So, we've seen a significant recovery. I think what's interesting is the callout box on the right. Year to date, we've only seen about 35% of trading days with plus or minus 1% or greater moves. Compare and contrast that to last year, in 2022, 90% of the roughly 250 trading days, Phil saw a plus or minus 1% or greater moves, which is tied for the largest of all time. So while this year is certainly volatile, make no mistake, and we think it's gonna get more volatile, not less volatile, it hasn't been nearly as rough as what we saw last year.

Phil: Right, which is always good to see. So, you can't talk about stock market or fixed income for that matter without focusing on corporate earnings. So what are we seeing in terms of consensus estimates? So consensus here is bottom-up analysts' estimates. So, an analyst who covers companies in tech or industrials instead of what are their expectations summed up. So, 2023 growth has moved down to just 1%.

Brent: Yeah.

Phil: So we've seen really severe downward revisions to this year. So when you think about, what was the market pricing last year, where it sold off 25%, well, it was looking ahead to this year.

Brent: That's right.

Phil: Last year. Let's look into a pretty flat earnings environment this year. Next year, 2024, 11.6%. Take that with a grain of salt.

Brent: Yeah.

Phil: Analysts haven't necessarily sharpened their pencil too much on it.

Brent: Good enough to get through this year, let alone figure out what it's gonna be for now.

Phil: That's right. But the trend expectations is basically disappointing earnings this year, better next year. Of course, we need to keep an eye on that. And of course, margins have contracted on the right side. Really back to sort of trend. We've had artificially high margins thanks to so much money entering the marketplace. Now, I should point first quarter earnings season what's interesting is, every sector, all 11 sectors beat on both top and bottom line, revenue, and earnings, which is great to see. The caveat is there were severe revisions coming in.

Brent: That's right. Low bar.

Phil: Low bar. So if you look at what were expectations for the quarter on Jan. 1, they, only three sectors of the 11 beat on earnings. So clearly a lowered bar, but nonetheless beat that lowered bar. So let's look at the path of earnings through time on the next slide. So here we're showing quarterly year-on-year earnings change. So 1-year growth or contraction, excluding energy.

Brent: Yeah. It's a big one. This is not just the S&P 500, it excludes energy.

Phil: And the reason we're showing this is with crude rising so much last year, energy was sort of this outlier earner. When you look at S&P 500 earnings growth X energy actually starts to contract the second quarter year on year last year. So when you think about the way the market behaved last year, bottom in October and you look at this chart—

Brent: Yeah.

Phil: From a core earnings perspective, it starts to make some sense.

Brent: Yeah. And we talked about this last time, but when you tie in or overlay, the stock market performance, usually, at least historically, the S&P 500 has bottomed or tend to historically bottom 6 to 9 months before earnings bottoms. So if I were to take a look at, adjust this back to throw energy back into the mix, looking at earnings bottoming in the first quarter, potentially, the bottoming in the second quarter, still a little tough to tell where that's going to be. That bottoming on October 12, at 3,577, kind of at least smells or rhymes relative to history in that normal bottoming cycle for the S&P 500 before earnings bottom.

Phil: So certainly could be a positive. Another positive on the next slide is the Fed.

Brent: That's right.

Phil: So generally, as you can see here, if you look at that that horizontal line, that's the final Fed hike of these various cycles all the way back to the 80s we're showing each cycle in line. You look, the 6 months prior to that last Fed hike and then the 12 months after, generally with one exception, which Brent will speak to in a moment, generally, the market tends to perform well after the final Fed hike. Now there's a little whisper in the back of my head that says, well, has the market figured this out? It's one of the reasons we're up 7% this year.

Brent: That's right.

Phil: But nonetheless, no matter how you look at the final Fed hike, is important for the market and tends to be a positive.

Brent: Yeah. I don't know why I always get stuck talking about the one exception. But so anyway. So when you look at the gold line, which is the 2000 cycle, what actually happened during that period of time. Right. The Fed was still hiking through the main meeting. Then you had the downturn, right? Sort of that the economic velocity started to decelerate. They started cutting rates in the December meeting. So, you had a very compacted period between the last hike and the first cut, which is, again, scarily similar to what we saw when we talked about the path of Fed fund futures and what the market's at least pricing. We don't believe that that's going to happen and, you know, knock on wood that that doesn't happen. But the last time we had a very compressed cycle between the last hike and the first cut, tended to be where the market didn't do so well, so let's knock on wood and hope that it doesn't happen.

Phil: Absolutely.

Brent: So, the question Phil, that you and I have been getting so much is not necessarily debt ceiling. It's not monetary policy. It's geopolitical events. Brent, there's still and Phil, there's still a war in Ukraine. There's geopolitical tensions between China and Taiwan, between us and Russia, between North Korea, Iran—name, name your problem. So, what we decided to look at is how do stocks actually perform around geopolitical events, and we're looking at basically, most, if not all geopolitical events of significant magnitude post the 1930s. We're gonna, we put a piece out, I think, yesterday, on this so you can read more about it, but I'm gonna sum this all up when you look at the date at the bottom. On average, the S&P 500 falls about 7.6% when that event occurs over roughly 16 trading days. The most important thing for listeners is that 90% of these observations, 12 months post, the S&P 500 recovered its previous high. So again, while it can get noisy around geopolitical events and while it can be protracted, by and large, more often than not, no matter what the event actually was, the market tends to resolve itself back to its previous high with, within the year of that event occurring.

Phil: Absolutely.

Brent: So, let's talk about what's probably on all of your minds. I, I don't think I can watch it anymore. The grandstanding as it relates to the debt ceiling. What's going on? So first, let's just explain what a debt ceiling is. It's not the ceiling above us. It's a legislative proclamation that basically says that our government cannot continue to finance their spending, i.e., borrowing, beyond a given legislative limit. So, in the 20th century, we've come up against this debt limit and raised that debt limit, Phil, more than 90 times. Right? So, this isn't a new thing. We've been here before. Similar to what we saw in 2011, similar to what we saw in 2013, a little bit in 2021, a little bit of political grandstanding, a little bit of world wrestling as it relates to talking about what's going on. It's also a presidential election year, so you would expect a little bit of this volatility. What we're looking at on the screen is how much money is left in the coffers? And if I were to adjust this on the fly, we're sitting at about 60 billion dollars. Right? So, treasury secretary Yellen has said we're going to likely run out of money whether it's June 1st, June 15th. Let's just say Phil, sometime soon. So ultimately, we believe, I'm gonna look at the glass half full that our government and our two political factions will come to a resolution sooner rather than later. I think the one thing that I believe is certain is that you're going to see an awful lot of equity and fixed-income volatility. Probably more like the 2011 situation, and if we go to the next slide, Amy, and take a look at what that looks like, you can see what the 2011 situation looked like. That's the gold line there. As we got to the problems later in the summer, you can see that big drawdown where the equity market didn't like it so much. Because they couldn't come to a resolution, then found its way back to break even. You can see the gray line is this market cycle. We are trading scarily close to the 2011 situation. Again, glass half full, we do believe that they're, they'll come to a resolution. Both sides, McCarthy and President Biden, and say that default is not an option. So, let's hope that cooler heads prevail.

Phil: And speaking of risks and sort of our views, let's flip to the next slide and look at our S&P 500 price target. So, this is a 12-month rolling price target. We originally set at 4,100 in December. We were remaining there. The market has traded to this price target. We're running right around 4,100 today, up 7% year to date. Our belief is there's going to be some choppiness, the remainder of this year when you think about the debt ceiling, so when you think about digesting the Fed, et cetera, so right now we have held our price target at 4,100. Again, if we have a 7% year this year, if you told me that on December 31st, I would have taken it.

Brent: That's right.

Phil: We've just had it early in the year.

Brent: Yeah. And this is why built into the portfolios that we have, we've had, we have less risk than the market built into our portfolios. Right? We believe in more diversification, not less diversification. And we do believe that fixed income, this time around, certainly for the shorter term, but also for the longer term that bonds play a very thoughtful role in providing that balance like we saw earlier on. So Amy, I can see that we've got a dozen or so questions piling up. Why don't you take us home?

Amy: Yeah. Thank you both for all of that information. If you're joining us for the first time today, first of all, welcome, and thank you for being here. We host this webinar every single month and have this market update commentary from Brent and Phil. And throughout the month, we have a number of resources that are also available including weekly videos, some written commentaries, and some other videos along the way. If you are interested in getting all of that content, be sure to hit the QR code there and fill out a quick form to get onto that subscription.

If you're using your phone to be on today's webinar, you can also visit firstcitizens.com/wealth to get onto that subscription.

Brent, Phil, before I ask you your first question, I noticed in the registration and today that there are several questions around the Silicon Valley Bank acquisition and to all of those questions, I think you'll find all of the answers you're looking for on firstcitizens.com on our Investor Relations page. I would also encourage you to go back and listen to our first quarter earnings call that was hosted just a couple of weeks ago. There's a lot of really great information there, and I think you'll find what you're looking for there. So, Brent, Phil, let's jump into questions. The first one, Brent, you're not gonna believe it, but what's the impact of the debt ceiling if the stalemate were to continue, short and long term?

Brent: Debt ceiling. Never heard of it.

Phil: Yeah.

Brent: So yeah. So look, we have been through this. This is not our first rodeo. More than 90 times just in the 20th century alone. I mean, and look, this legislation goes all the way back to 1917. So, we, we've been here before. You know, short term, very easy response, more volatility, both in in equities, in fixed income, in rates, in currencies broadly, Again, we do believe that cooler heads will prevail. We do believe that they'll come to a resolution. The one thing that, that I failed to address and I'm glad that it's coming up in questions is, there's two potential optionalities as it relates to what they decide on. One would be kick the can short term, which is extend the debt ceiling limit through September 30 of this year, which we would hope that that wouldn't be the case because that introduces more volatility, not less volatility. The other one would be to come to a broader resolution that kicks the can for potentially another 2 years or so, which we hope is the outcome. If we get the latter, we believe that the markets would look at that in a more positive light. Hopefully, that, that yields would fall, and equities would do a little bit better. If we get more of a lack of conviction and we kick the can shorter term, you might see more volatility, more of an equity sell off more of rates going up than you would otherwise.

Phil: Yeah, for markets, it's a, it's confidence. Right? Obviously, to get past debt ceiling and actually pay debts that are due.

Brent: That's right.

Phil: That, that, that's—

Brent: We're not talking about future stocks—

Phil: When you look at 2011, a lot of it had to do around confidence.

Brent: Yeah.

Phil: Right. Can we govern?

Brent: That's right.

Phil: So certainly, the latter option of longer-term solution is preferred from a market perspective.

Amy: Thank you both and just a reminder to everybody on the line. If you have a question, feel free to use the chat or the Q&A feature and we'll get to as many as we possibly can. Phil, next question, if the job reports continue to be strong, will that carry into the Fed's decision to continue to raise rates?

Phil: You can't think about Fed policy without thinking about the labor market, right? There's consumer inflation, but there's also wage inflation. We normally show wage inflation in all of our charts. We do not show it this time, but basically what you're seeing is wage inflation is turned over, but if that were to pick back up, that feeds right into inflation.

Brent: Absolutely.

Phil: There's no question the job market is part of the story. We have a fresh jobs report next Friday. So, a week-and-a-half away. Expectations are for the pace of, of gains to slow, up 200,000, and for the unemployment rates tick up a little bit. It's no coincidence that economists expect that when initial jobless claims are going up, right? So that feeds directly. The softening we are talking about is just that it's really a loosening on the margin but that is important. So, if you're the Fed and you're on pause, one of the reasons is that job openings are coming down, that the pace of job gains is some initial jobless claims are going up. But absolutely, to the question, if it were to reaccelerate, we were to see really gangbusters labor market, reacceleration over say, the next few months, that, that is gonna force the Fed's hand.

Brent: Absolutely, right? And which is one of the reasons why we believe that rates are gonna be higher for longer, right? We don't really think that we're past the stickiness and until we start to get that directional vector moving in in the right direction, it still, it's gonna be choppy and it relates monetary policy. That's right.

Amy: Phil, let's stay on rates for a second. So how long do we anticipate interest rates to be above 4 percent?

Phil: So we'll, we'll focus on short-term rates. Ten-year treasuries are already back below four. So, let's focus on on short-term rates. So the Fed fund rates at five and a quarter percent. The Fed themselves are saying 4.3% as of end of next year. The Fed, they're saying we're going to stay, we're going to come down from where we are. Right?

Brent: Yep.

Phil: But we are gonna be elevated north of 4%. Futures markets believe it's gonna be well below 4%—

Brent: Like June of next year.

Phil: Yeah, that's right. Well below four. I think the answer is probably somewhere in the middle, so I would not be surprised to see the Fed funds rate dip below four at some point next year. But as we've said, we don't think the Fed's gonna rush this year. That is really something later next year again, 60% chance of recession. Right. You have an economic slowdown. That forces the Fed's hand in the other way. We think they're gonna be resilient or resistant, I should say, in terms of cutting. But, no, sometime next year would not be all that shocking if the data cooperates.

Brent: Yeah. You said it best earlier, Phil. Right? Right. If you look at the magnitude and speed to which the Fed hiked in this cycle and if you truly believe that that works with long and variable lags, you can't do knee-jerk reaction in policy until you're sure that those long and variable lags have worked themselves through or not. Right? So, everyone's so worked up, like I said, are we done, are we done, are we done, relax.

Phil: Yeah.

Brent: We gotta figure out, let the data come through, and figure out whether we're actually through that. But at least the Fed is to some degree, in my opinion, in a driver's seat, because it's much easier to cut—

Phil: Right.

Brent: Than it is to really hike as you think about what that actually does to the wrong—

Phil: And look, if inflation and the economy are both slowing dramatically as we enter next year, they'll have the green light to cut.

Brent: Absolutely.

Amy: Let's switch gears to real estate. I'm seeing several questions on that. I got a question around the commercial real estate market and the future of that as well as the residential world, but specifically with commercial real estate, what will happen with empty office buildings as people are more often remote now and that sorta thing.

Phil: Look, it really feeds back to the index we showed showing 15% contraction in commercial real estate. Right? So it, the market's already reacting. This is not news to the market. The market knows that they're for certain urban areas, there's a lot of office vacancy for example.

Brent: That's right.

Phil: They, the market knows there's right now a split in a lot of urban areas between urban and suburban. Right?

Brent: That's right.

Phil: So my answer would be, the market’s already reacting.

Brent: Yeah.

Phil: Read the, if you open up the Journal, you'll find an article most weeks of some office building that's selling for a discount versus where it was. So I think this is already happening. Is it a risk? Absolutely, it's a risk.

Brent: For sure.

Phil: It is a known risk, something we're talking a lot about, we're hearing others talk about as well, and it does feed into the banking industry as well. So some of those concerns there too. But, yes, it is already a problem. I think it's already affecting prices.

Brent: Yeah. And let's talk about it from the investment side, Amy. And let's shift gears a little bit related to that. Let's talk about private real estate.

Phil: Yep.

Brent: Right? So remember, those marks, those mark to markets are usually on lag, usually 3 months. Sometimes, depending on the property, it could be longer than 3 months. We're now just starting to see those marks coming down. Right? I think that those marks in private real estate are gonna continue to come down, but I think ultimately, people will go, well, well, geez, then then maybe I don't wanna be in private real estate. Yeah. That's not really how it works. Presenting an opportunity as those marks start to come in lower, looking longer term, where do you wanna buy when marks are coming down and down and starting to potentially trough? Or do you wanna buy when the marks are high? You wanna buy them when the marks are low.

Phil: Buy low, sell high?

Brent: Exactly. I think that's what they say. Ultimately, longer term, that might lead to opportunities within the private real estate sector, not necessarily right now, but maybe over the coming quarters and years, as well as private credit when those marks start to come in and hopefully mark lower.

Amy: Brent, what education would you give to a beginning investor who is looking for a passive monthly investment?

Brent: That's a great question. The first thing is to do something completely non- investment related, which is work with a financial professional and get a financial plan. There is nothing that'll allow you to sleep better at night than having a comprehensive financial plan to make sure that all your goals and dreams are laid out on piece of paper and are thoughtfully planned for. It doesn't necessarily mean it's gonna make everything work out swimmingly, but without a plan, you're basically investing and flying blind. So I would say to that to that listener, get with a financial professional, get a comprehensive financial plan and then ultimately invest in a diversified portfolio that's congruent to that financial plan that allows you to take care of both short, intermediate, and long-term goals and objectives, and then don’t do what we do for a living, which is worry about this stuff 24/7.

Phil: That's right.

Amy: Brent, we're, we're already a couple of minutes over, but I do have one more question here if that's okay. Do you have any recommendations for an alternative to bonds that represents the fixed-income portion of an equity investment portfolio, or do you still feel that a mix is the right way to go?

Brent: Yeah. That's a great question. In in my opinion, if you were asking me this back in 2021, Phil, or 2020, then you might be looking for alternatives. But as Phil nicely highlighted, the Ag Bond Index is sitting at a purchase yield of or yield-to-worst on 4.6%. Investment-grade corporate bonds are north of 5%. High yields over 8%, emerging market debt is almost 9%. So why do I need an alternative? No. You just need to embrace a thoughtfully diversified portfolio of US and global bonds in your portfolio. You don't necessarily need alternatives or broadly leverage in those public market exposures given the interest rate environment that we find ourselves in, we do believe that the intermediate to longer-term expected returns for fixed income going forward from where we are after the dislocation that I talked about, which was the worst drawdown ever for fixed income. It was what I just saying about the private markets. You have the opportunity to buy into fixed income after the largest drawdown of all time. Sounds like a great idea. Have a diversified portfolio. You don't necessarily need to look to alternatives. Think about blocking and tackling fixed income. And again, make sure that it's congruent to your diversified portfolio and your plan. But I don't necessarily think that you need to look to as many alternatives as maybe you did a couple years ago.

Amy: Well, thank you both for answering questions and giving us all of that information. I just wanna thank everybody on the line for trusting us to bring you this information, and we hope you found it helpful. We'll be sending out information on June's Market Update in the coming days and thank you for being with us today.

Making Sense In Brief Outro Slide

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