Making Sense: November Market Update

Amy: Hello, everyone. I'm Amy Thomas, a strategist here at First Citizens Bank. I'm joined today by Brent Ciliano, our Chief Investment Officer and Phil Neuhart, Director of Market and Economic Research.

Today is Wednesday, November 15th, 2023, and I want to welcome you to our monthly Making Sense: Market Update series. Before I turn it over to Brent and Phil, I do have a couple of reminders to share with you. First, we received a number of questions from you all through our registration process, and we will answer as many as possible on today's discussion. But 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 and opinions of the authors at the time of recording and should be considered for educational purposes only. Brent, with that, we're ready to go, so I'll turn it over to you.

Brent: Great, Amy. Thank you, everyone. Hope you are well. Phil, I can't believe next week is Thanksgiving.

Phil: It's hard to believe.

Brent: It's hard to believe. I didn't do any Christmas shopping. I've got to get you my list. Can you do all that shopping for me?

Phil: Yeah. I'll take care of it.

Brent: Fantastic. Well we've got a lot to cover today. We're going to give you an economic update. A lot of data, Phil, that's come in. We'll cover a good bit of that. Then a market update—crazy. We've had a Santa Claus rally here—9.3% in the last two-and-a-half weeks, Phil, just crazy. So we'll talk about where do markets go from here, both equities and fixed income.

So, Amy, let's jump in. Let's start with the economic update. Let's talk about growth here and abroad.

You know, Phil, coming into the year, expectations were that significant monetary policy actions here and abroad would curtail growth. Expectations from a consensus perspective had us falling from 1.9% in 2022—all the way down to 40 basis points, significant moderation.

Now we're sitting at 2.3% for growth for this year, significantly different than where we started the year.

Phil: Yeah. Real outperformance in terms of the economy.

Brent: It's just amazing. So not only are we not going to contract from 1.9% to 0.4% like we originally thought—we are now going to expand by almost 40 basis points. So just a really significant turn of event. The US economy has been much stronger. The labor force has been strong. Consumers continue to spend on services. So it's been a significant expectation betterment than where we originally thought. And here we are sitting in the fourth quarter.

Expectations again that significant monetary policy actions—and the long and variable lags associated with those actions—are going to slow growth in 2024. Expectations are that we're going to potentially fall from 2.3% down to a meager 1%.

And broadly—economic activity, Amy, on the next slide, is slowing. What we're looking at here, gold line is manufacturing. Gray line is services. And you can see both have materially moderated lower from the multi-decade highs, Phil, that we saw back in 2021.

Let's start first with manufacturing in the gold line. And not only have we moderated lower, we've actually fallen below the line that divides expansion and contraction. Above the line is expansion. Below the 50.0 is contraction.

So we've moderated lower to 46.0 as of June. We had a strong third quarter—3 consecutive months of betterment—only to fall back in the October reading from 49.0 to 46.9. So we are not yet, Phil, out of the woods as it relates to manufacturing.

On the services side, moderated lower just like manufacturing but stayed in expansionary territory—similar to what we saw with manufacturing, Phil. Services had moderated lower in October from 53.6 down to 51.8. So, again, activity broadly is slowing.

One of the reasons for that on the next slide is that monetary policy actions. We are looking at—here on this slide—at all cycles post-1982, and the gold line is this hiking cycle. And you can see Phil, the most significant cycle that we've seen in more than 40 years as it relates to, you know, basis points of hikes in a more contracted period of time.

Phil: Yeah, and you can tell that that's really the outlier, right? So if we look forward—look at Fed funds futures, which are certainly not always correct, but an indication of what the market's thinking. One, it thinks the market—the Fed is on hold in December. Only a 2% chance that the Fed moves in December. So 98% chance they hold.

As you look into next year, you have seen a pull forward in some of the recent dovishness in the marketplace—or belief around the Fed's dovishness—a pull forward to the first cut being in May. And now looking at the full year next year—four cuts—1%, 100 basis points worth of cuts are expected next year. We shall see.

These things are moving rapidly, literally day to day. But the real point being that the Fed's going to be at its current level for some amount of time—well into next year unless something changes pretty dramatically in the economy.

So speaking of the Fed, as we flip forward, here we're showing the Fed funds rate through time. You can, of course, see the very low rates after the financial crisis. Our little stair step up, down during the pandemic and now back up again. You can of course see how rapid the hike in the Fed funds rate is in the gold bar here.

The gray bar is the proxy effective funds rate, right? And this is a little technical, but it is from the Federal Reserve. They publish this, and they use their balance sheet actions, forward guidance and other measures to find "What is the Fed funds rate, really, when you look at the whole picture?"

And what it shows is that the Fed funds rate is closer to seven in the proxy—7% compared to where we are in terms of the real Fed funds rate with a five handle. So what does it mean? It means that financial conditions or monetary policy is even tighter than you might think. One thing that's just interesting from a historical perspective is look at the period after the financial crisis, 2010 through 2015.

Brent: All that quantitative easing.

Phil: All that quantitative easing—the proxy rate was actually negative. So we might have had a positive Fed funds rate, but just to remind you how easy monetary policy was and how we are now in a paradigm shift. And markets are having to contend with that.

So why is the Fed tightening so rapidly? It is about inflation. Consumer Price Index peaked last June at 9.1%. We just this week got fresh data. We've fallen down to 3.2% today. You'll notice that that gold line is now moving around a little bit year on year. It's not the straight move downward. Clearly it's easier to go from 9 to 4 than 4 to 2.

Brent: Correct.

Phil: Core inflation is sitting at 4%. That excludes food and energy. That's the grey line here. So we do have core inflation still above that headline inflation. If you're cheering for the Fed to ease monetary policy quickly, you were cheering for both sides to drop and core inflation to get closer to headline inflation. We don't want to see the underlying inflation.

So where might inflation go as we look forward? We show this chart often because right now inflation is really the whole story. We'll talk about the importance of interest rates to the stock market a little bit later. So what does consensus believe? It believes that inflation's going to continue to moderate—but at a pretty slow pace. By the end of next year, you're at 2.4%.

Brent: Yes.

Phil: Reminder, the Fed's target's 2%. And they're—if you listen to Fed speeches, et cetera—they're sticking to that target. So that is why the concept of the Fed cutting really aggressively next year—outside something happening economically—the market has come to terms with that being unlikely. Cuts, yes. Aggressive cuts, say early in the year, the market is not pricing that because inflation's still elevated.

Brent: Yeah. And, you know, that higher-for-longer narrative is likely to be there and that last mile as you've always talked about is the hardest, and again, understanding that from a long-term perspective. Yes, the last 20 years have seen inflation about 1.9%, but longer than that—so when I go back more like 50 years—you have long term inflation running at about 2.7%.

So, again, where we ultimately settle, we'll just have to wait and see, but it's going to take some time.

Phil: To that point, the question is "Is the Fed's 2% goal aspirational? And they're okay with 2.4%?" I think that they probably are, but communicate to the market, they have to stand firm.

Brent: Absolutely. And one of the pillars of strength that we've seen on the next slide, Amy, has been the labor market. And we've seen, Phil, hundreds of thousands of jobs created this year. But at the margin we're starting to see the labor market start to slow. The October reading—consensus expectations were for 180,000 jobs—we came in below that at 150,000. That gangbuster September report that we got at 336,000 jobs got revised down to 297,000 jobs.

Now, Phil, there's some noise in there with, you know, UAW workers and screenwriters, and so we're going to probably have to get and wait till the November and December readings to get a better picture of where we ultimately end up, but I know what you and I are watching is really the U3 unemployment rate.

We hit a low at 3.4% back in April, which was, you know, a multi-decade low in unemployment. But we've now ticked up to 3.9% in October, almost a 50-basis point move, and historically, when we've seen that significant of a move—50 basis points or higher—that's usually portend a recession. Again, we're coming off of a ridiculously low base, so maybe this time is different, but it's absolutely something that you and I are going to be watching.

Phil: Absolutely. So speaking of the labor market on the next slide, let's talk participation. So number one complaint we still hear from our corporate clients is labor availability. For the vast majority of industries—not every industry—but the vast majority, there's still real issues finding labor.

A narrative coming out of the pandemic was, "Well, Americans just don't want to work anymore, right? They receive their fiscal stimulus checks. They just aren't working." And while participation fell materially during the pandemic, if you look at prime age participation on the left side—this is age 25 to 54. What you'll notice is participation is actually above the 2019 peak. So the truth is among core age workers, you are seeing more people working as a percentage of the population than before the pandemic, so this is good.

Brent: Yes.

Phil: The right side is really the driver, right? Age 55 and older is declining. Why is that? The baby boom is retiring. The pandemic likely pulled forward some retirements. We all know someone who was a year or two away from retirement and said, "I don't want to learn how to use Zoom. This is it for me," and pulled forward. But you aren't seeing that bounce back. Why is that? Because the baby boom is retiring.

So some of the issues in terms of the tight labor market are not just cyclical. They are structural and something I think we'll be contending with for some time.

Brent: Yeah. And I see you looking at me. I, you know, I've still got about 20 years in me, Phil, so I'm not going to be in that camp.

Phil: Okay. Okay. We'll see.

Brent: So let's talk about wages and wage growth because, you know, Phil, that's critically important to allow consumers to continue to spend. And you can see here, you know, wage growth has moderated lower—like a lot of these charts that we are showing—over the last year. But sitting at 4.1% relative to the 3% long-term average, we're still materially above the long-term average. So the confluence of still decent wage growth combined with a labor market that's still in good condition, we believe will facilitate and allow consumers to continue spend.

Phil: And to the point on consumer spending, which I know you'll cover in a moment—that wage inflation is above price inflation.

Brent: That's right.

Phil: At 3.2%. That was not the case—

Brent: Yep. So real wage growth.

Phil: —much of last year. So you are seeing real wage growth, which is one of the reasons the consumer continues to spend.

Brent: Yeah. So, you know, let's focus on the next slide here, which is arguably one of the most important because consumption makes up, Phil, more than 72% of US real GDP.

68% is consumption. Another 4% is housing. So as goes the consumer, as goes our economy. The gold line here is spending on goods. The gray line is spending on services. And again, similar theme, you can see both have moderated lower from the highs that we saw back in 2021.

The goods spending has now moderated below the long-term average at 3.3% versus the average of 4.4, but you can see a little bit of a tick up. We'll have to see what the holiday shopping season looks like. I know that there's already Amazon boxes piling up on my front porch. So maybe that's a good sign.

The gray line on services. The good news there is that we're still clocking it at 7.2% versus a long-term average of 4.7. And when I break down consumption—more than 75% of overall consumption is spending on services. So the good news is that services is still clocking well above the long-term average and is a major component of consumption.

Phil: Yeah. It is truly what's carrying our economy. So let's talk—one risk to the economic outlook is on the next slide—commercial real estate. This is something that's certainly a known risk. You can't open up the financial press without seeing an article about commercial real estate in one area or another. If you just look at commercial real estate across everything—this is office, apartment, industrial—nationally, year on year, you can see price declines.

The most current rate is about 7% year on year decline. That's about 19% from its peak. So you are seeing price decline. Now commercial real estate—like all real estate—really depends where you are geographically.

And what are what are we talking about? Are we talking about office, industrial, apartment. Urban office versus suburban office might look different. So it really depends on the specifics of where you are, but there's no question that commercial real estate is something that we think is going to stay in the news for some amount of time.

Brent: Agreed.

Phil: So the number one question we get from the economic perspective—it's been the case now for a year, year-and-a-half, which tells you something about expectations—is "Are we having a recession the next 12 months or not?"

We've been slightly greater than a coin flip, roughly 60%, but the truth is the economy's been more resilient. Consensus has been basically near where we are. Same thing. The economies outperform, which is great to see. So on this t-chart, let's just discuss. I'll take the positives first. How do we avoid recession?

So, one, resilient labor market. We discussed that a lot. The labor market's key to consumption. Point number two, nearly 70% of GDP's personal consumption. That is really supporting the service economy as Brent just showed.

And then residential construction—we dug in deep on housing last month. This month we are not, but just quickly, there is so little supply of homes in the resale market that you're seeing housing starts at levels above the average 2019 level. So there is residential construction to fill that tight supply gap even though mortgage rates are high and existing home sales have fallen.

Brent: Yeah. And, you know, I'll certainly focus on, you know, why we could have a recession over the next 12 months. You know—we highlighted it in depth, and we've been covering this almost every webinar—is that, you know, this most significant monetary policy environment that we've had in more than 40 years has led to tighter financial conditions.

On top of the tighter financial conditions, we've had the treasury yield curve move up. Yields have moved tighter, which has tightened financial conditions. We've seen that feed back into the banking sector on lending, et cetera, et cetera—tightening financial conditions. Overall, manufacturing highlighted—obviously, manufacturing is still in contraction—it had gotten better but has fallen back. So we are not yet out of the woods as it relates to manufacturing and something that we're absolutely watching.

The yield curve has been inverted for most of this entire year. We were at more than a 100 basis points inverted. Now that's come back, but usually and historically, an inverted yield curve has portended a recession. We're going to have to watch and see. And you just highlighted very nicely that the commercial property market has seen some major contraction and that's something that we're significantly going to watch.

So let's shift gears and let's talk about this market—both equities and fixed income. Let's start on the equity side. We show this slide every single time. We'll start on the lefthand side. Let's look at equities, which is to the left of that dotted line.

Starting with the first sets of bars, US equities, I'm going to update this on the fly, Phil. Through November 14th, US equity markets are up more than 18.7% year to date, which is incredible. Developed international equities is represented by the MSCI EAFE—up more than 9% year to date through last night. Emerging market equities up almost 3%. So by and large, we've continued to see the equity markets both here and abroad doing well.

To the right of that dotted line when we look at taxable and municipal fixed income, updating the US aggregate bond index is now in positive territory through November 14th—up about 40 basis points. I'd call it more flattish, but a good directional move. Municipal bonds are up about 1.2% through last night. So again, both across fixed income and equities, we're looking at positive markets, which is a great thing to see given where we were in 2022.

When we look at where specifically in US equities, we continue to see mega-cap stocks doing well this year. Both blend, large-cap core and large-cap growth continue to be the biggest drivers of performance in the equity markets, and we've seen that basically almost from the start of this year through November.

So let's get a little bit more under the hood on the S&P 500. Look at the chart on the left. It's been incredible. I'm going to update this on the fly. We are now more than 26% above the October 12th of 2022 lows.

And while we've seen—you can see the -8% and -10% contractions that we've seen year to date—still below the long-term average of -15% intra-year drawdown. But what I thought was really interesting, Phil, is we are only about 2% away from the July 31st of this year S&P 500 high. But interestingly, Phil, we are only 6.3% below the January 3rd of 2022 all-time high in the S&P 500. So we've made up an awful lot of ground over the last two-and-a-half weeks.

From October 27th to November 14th, we are up 9.3%, which is still why you and I always talk about—you have to stay invested. Trying to time market ins and outs can get you caught. And it's been an incredible rally.

On the righthand side, what has been interesting when I look at the S&P 500 and the cap-weighted index, which is that first line, versus the equal-weighted S&P 500 index—you can see what a bifurcated market it has been year to date. And sort of the larger-cap names within the S&P 500—the Magnificent 7—have been driving returns much of this year.

Phil: Yeah. It's certainly been a narrow rally, Brent. Let's turn ahead to some fundamentals. Let's discuss earnings for a moment here, 2023 earnings. We just finished third quarter. So we're three quarters through. About 80% of companies beat admittedly a pre-lowered bar.

Brent: Right.

Phil: But 80% of companies beat—obviously, some notable misses. Look at the year as a whole. Earnings are basically expected to be roughly flat this year—up 0.6%. That number has come down a little bit as we've seen some revisions for fourth quarter numbers.

Looking ahead to next year, earnings expectations are now 11.6%. That number was north of 12 not that long ago. This is kind of the pattern you tend to see is that expectations for the out-year are very optimistic and then start to come down a bit, right?

So not too surprising if we see that in coming months as we get through the fourth quarter. The average growth since 1950—7.6%. But what's important—it might be one reasons the market has been so resilient this year—is on the right side.

This is forward operating margin expectations, right? And what you'll see is margins came down off the really wild peaks we saw post-pandemic to more normal levels. Right? But we have now seen a recent uptick. That recent uptick in margins, look, stock investors like to see margins expand, right? So, seeing that uptick is certainly a positive for the market as we slowly march hopefully back to those previous highs.

So I alluded to the concept that the stock market and interest rates feel pretty tied these days. More so than when interest rates were just low for an extended period. The stock market's really watching the Fed and the interest rate market. So here, what are we showing? We're showing the S&P 500 in the gold line, and then bond volatility—what's the volatility of the bond market—on the right side. That axis is inverted, right? What you see is these are moving together. In other words, when bond volatility falls, the stock market's doing pretty well. When bond volatility rises, as we saw over the summer, stock market sells off. Now more recently, you see that gray line tick up and the stock market tick up. What it means is dislocations in the fixed income market—equity investors are watching and watching very closely.

So right now, it's all about fixed income in terms of global markets.

Brent: Yeah, and I know, Phil, on the next slide, one of the questions that you and I got an awful lot through the late summer—specifically in September as the equity markets sold off—is "Hey, what will the fourth quarter look like? Are we going to get a Santa Claus rally like we've gotten in previous years?"

So what we're looking at here is post-1960. All years where the S&P 500 was up 10% or more from January to July and we had a downturn in August and September. What did the fourth quarter actually do? And you can see a pretty consistent pattern of good January to July, you have volatility in August and September and the fourth quarter was pretty good.

So you can see that this year is falling right in line with that historical trend. And right now, if I were to say "Where are we from basically, you know, October 1st all the way through to November 14th?" We are up more than 5%.

So again, we are now recording this right around November 15th so we are almost exactly halfway through the fourth quarter, and so far, we are falling right in line with history.

Phil: That's right. So what are our expectations on the next slide? This is our S&P 500 price target. I won't dwell on it too long because we have not changed this this month. Our base case is 4650. As of Friday, that was up 5.3%. As of yesterday, it's now only 3.4%.

Brent: Right.

Phil: So markets are moving very rapidly. But when we raise this price target, we had the view that some of the sell off over the summer was potentially a bit overdone. But still a pretty constrained base case. Remember, this is below the January 2022 high.

So when we speak about risk, and you say, "Well, your price target is up." The truth of the matter is—yes, it's up, but it's fairly contained at least at this moment. If you were very bullish, you could see our bull case there. And bearish, we're of course outlining our bear case as well. So this is really our framework.

Brent: Yeah, and I think it is good to see that, especially when you look at the bear case—and God forbid we get back there—it's still above the October 12th of 2022, you know, low that we had. So we think knock on wood that we may be by the worst as it relates to lows in the equity markets.

Phil: That's right. So often—and you already sort of alluded to this—we get the question on "When should I put money in the market?"

Brent: It's my favorite new slide, by the way, Phil.

Phil: I love this slide that the team produced. Number one question, honestly, is— well next year it'll be elections—but in non-election years, the number one question is, you know, "When should I put money to work?" And our answer is always—do not try to time markets. And we, you can show this many ways, but here is an exercise our team did.

If you contribute from 1980 through 2023—$12,000 annually, right? But you contribute in different ways. Four different scenarios.

So the first scenario is perfect timing. You're omnipotent. And you're able to buy each year at the yearly low. Right? Which, by the way, this would be impossible, right, to do this for decades on end. But let's just say you're all knowing.

Okay. That perfect timing—$10,500,000 dollars. $12,000 a year from 1980.

Brent: The power of compounding.

Phil: So let's talk about the other scenarios. Worst timing—this is you're all unknowing. Right? You, somehow, every year you buy at the peak.

Brent: Yeah. Murphy's Law kicks in, which a lot of clients say, “Hey, I always feel like I'm always putting money in at the worst time.”

Phil: Right. So you're buying at the peak every year—also an impossibility, right, to pick the one day. But if you did that, you still get 76%. This is the percent capture—76% return of that perfect timing scenario.

Brent: Amazing.

Phil: Right, which again, it's impossible, but it's to show that even if you're terrible at times, you get three quarters of the return.

More reasonable options. First day of the year, you put in $12,000—92% capture of that perfect timing, 92%. Monthly dollar cost average. Also something a lot of people do—so you're just putting money in each month, equal amounts—1,000 a month, 87% capture.

So what's incredible is really no matter which scenario—you win by investing. Look at cash through the same time frame, 5% capture. So, yes, there are years that cash outperforms. Why? Because stock market declines. It fell last year.

But over the long term, being invested and staying invested and not worrying about the day you put it in—just putting the money into the market over the long term—works. Now, of course, this needs to be consistent with your financial plan, with the buckets of assets you need. Cash is an important bucket, right?

But for your long-term investments where equity is appropriate, where it fits with your plan—it certainly can work over the long term.

Brent: Yeah. So let's shift gears and let's talk about fixed income, Phil, and I know that this is the treasury yield curve, but it looks more to me like an abstract piece of modern art. The gray line is the treasury yield curve at the beginning of the year, and the gold line is the treasury yield curve as of the 10th of November.

And what you can see across the board, Phil, is that yields from 1 month all the way through 30 years have moved up significantly. I think the thing—you know, in trying to update this as we do—is crazy because as you talked about bond volatility has been here for quite a while, here to stay.

What I think is most interesting is—where we look at that bond volatility—is that, you know, just in this fourth quarter alone, 2-year yields have moved more than 38 basis points, and the 10-year yields have moved more than 43 basis points within the fourth quarter alone.

Phil: Right.

Brent: So when we talk about bond market volatility, we think that it's absolutely here to stay.

Phil: So we often—and you hear in the press—and we even alluded to it previously is the inverted yield curve. So you can see that here this yield curve is downward sloping. So how does that slope change through time, as we flip ahead, Amy? So here we're showing the 2-year versus the 10-year treasury. In normal times, the 10-year treasury yields more than the 2-year treasury. Right?

That is not the case right now. Right now, the 2-year is above the 10-year. You can see, of course, that we've been below that 0% line for some amount of time. But the reason we're showing this is because we have seen a real narrowing in terms of the yield curve inversion. This could be a positive. Maybe financial markets are telling us something. Maybe it's just noise.

Brent: That's right.

Phil: But it is interesting that you are seeing the spread between the 2-year and the 10-year narrow on trend. There's volatility around that—but something potentially good to see.

Another metric we watch in terms of fixed income is credit spreads. Option adjusted spread in basis points is what we're showing here. What does that mean? What it means is—what is the spread above treasuries that investors are demanding from corporates, from corporate bonds?

So in other words, you know, if that spread goes up, it means there's more risk in the corporate world versus treasuries. If it goes down, it means there's less risk. What's interesting is even with some real concerns this year, right—you think about regional banking issues in March and other concerns—spreads are still tighter than they were late last year.

Right? We're showing 194 and where we were through Friday. So it is interesting. Yes, spreads are above where they were the very low levels post-pandemic, but we have not seen a spike in spreads. For now at least in the corporate bond market, you are not seeing real dislocations priced.

Brent: Yeah. And if we broaden this out and we look at various fixed-income sectors on the next slide, and you know that we've covered this slide for a while, right? So think about the starting point where we were at the beginning of 2022. Yields across various fixed-income sectors—whether it's government debt, Ag Bond, municipals, investment grade, sub investment grade bonds—were relatively low and sanguine.

And then you see where we are today, right? Finally, you're getting compensated for investing in fixed income through purchase yield. And then you run your eyes down that list. You can see right now if I bought the, you know, the Bloomberg broad aggregate bond index and sitting right now at a yield of about 5.4%. It's come down a little bit—maybe about 5.2% and change right now.

You're getting compensated as it relates to forward expected return, and I know that that we did a piece that talked about, you know, what is your total return capture as a percent of that starting point—and again, bonds across the board are offering opportunities. So when we think about the context of building portfolios, equities, fixed income—we think that our clients over time can have a more balanced approach to investing between equities and fixed income and get decent yields and hopefully be able to sleep better at night when they have a little bit of that balance.

So one of the questions that I know, Phil, that you and I have been getting a lot—especially with what was going on as we were heading into this government shutdown. Thankfully it seems like we're going to be by the worst. It seems like government finances, our outstanding fiscal deficit, our overall aggregate debt levels now approaching almost $34 trillion are constantly in the news. The chart on the left is where our federal debt as a percentage of GDP is right now. And you can see north of 100%.

And when we look at that dotted line, which is the CBO's projections, expected to continue to rise over time, so thinking about what that would mean. But it's really the chart on the right that's peaked a lot of people's interest. I know there's been articles in the financial news media. The gray line is actually the weighted average cost of all that almost $34 trillion of debt, and then that gold line is the net interest cost as a percentage of aggregate tax revenues. And you can see right now—the weighted average cost of that $34 trillion of debt is basically almost 3%.

And right now on a fiscal basis—total interest expense is now more than $1 trillion.

Phil: And the truth is, Brent, that this data is generally lagged, right? I mean, the weighted average cost of debt is going up through time because each treasury bond that's issued is at a higher yield than it was, say, a couple years ago.

So the truth is—these numbers, that gray line is higher than even what we're showing.

Brent: Yeah. And it's crazy. If you think about where we were in 2021—total interest expense was $306 billion or 4% of annual fiscal budget, right? We're now talking about more than $1 trillion, which is now 15.6% of aggregate tax receipts.

So at some point in time, we've got to hope that either interest rates come down, we have bipartisan fiscal austerity and start to think about our overall debt levels and what that means to the sustainability of our country and certainly one of the most important bond markets in the world.

Phil: And, look, it's going to be a real topic as we move into an election year, as well. This is not a topic going to go anywhere.

Brent: Yeah, and certainly raising taxes and spending less is not usually a platform that politicians like to run on. So we're going to have to see, and it's certainly going to bring, we think, a lot of volatility.

So, Amy, I see we have a lot of questions. Do you want to jump in right after we cover our Making Sense, here?

Amy: Yeah, sure, Brent. Thank you so much. And thank you both for jumping, taking a deep dive in the markets and the economy. There's always so much to consider throughout the month.

Just a reminder to all of those who may be interested in staying informed throughout the month, we do have several publications available to our subscribers, including a weekly economic outlook from Phil in our "In Brief" series. That's delivered at the start of every single week. If you're not already subscribed, be sure to hit the QR code and get signed up.

Also, I want to invite you to take a look at our brand new market outlook page where you can find an archive of past videos and commentaries just to keep yourself informed. You can also submit questions to Brent and Phil right on that site. So please submit your questions there.

Brent, speaking of questions, we do have several that we will jump into. Give me one second. So, yeah, just jumping right into the Fed—is the Fed done hiking and are we in soft landing territory?

Phil: Yeah, it's a great question. The Fed is likely done hiking. I mean, that's our base case. That's what the market is pricing. Fed speakers are certainly leaving their options open. They're going to talk about data dependency, et cetera. But especially with this week's CPI data coming in a bit softer than expected, which is a good thing—below inflation expectations. It is highly likely that we think the Fed is done hiking.

Obviously, things can change quickly. Are we in soft landing territory? Look, there is a reasonable percent chance we are. As I said, our recession probability has never been higher than 60%. What does that mean? That means basically 40% soft landing. Right?

So it's always been, we think, not a slam dunk that we're going to have a recession. It's a possibility. When you think about that t-chart, we outlined, there are real risks on both sides. The truth—is it still takes time for all these higher interest rates to feed into the economy, right? So there's a real risk out there.

But, look, as long as the labor market remains strong and the consumer keeps spending—that can keep us afloat, although we do think that there are risks out there, as we outlined.

Brent: Yeah. I think you hit it really nicely. It's the labor market, the labor market, the labor market. We're going to have to continue to watch—specifically jobless claims and continuing claims—to make sure that we don't see that labor market materially unravel. And as long as consumers are gainfully employed and they're making a decent wage, we believe that they're going to continue to spend, right?

So again, if we do have a recession, we think it might be a shallower one, and certainly not something that's deep and protracted. But again, as we've seen this year and the year before—things can change very quickly, and we're going to have to keep an eye on things.

Amy: Brent, as you've already alluded to—we're just under a year away from election day, so let's go ahead and start talking about it. Should I—this question is—should I be more conservative in my portfolio next year on account of the election volatility?

Brent: Yeah, at a broad level, investors should not be using exogenous events—whether that's a war in Ukraine or Gaza or, you know, elections in our country or abroad—to drive their asset allocation and their investment decision.

Phil: Yeah, if you look at geopolitical—we showed it to you I believe last month— Brent, if you look at geopolitical events all the way back to World War II. The impact on the market's generally pretty short-lived. These events are terrible. They pull at the heartstrings, but pretty short-lived. That's not necessarily an election. But generally in election years, Brent, maybe you could speak to sort of the performance around election years.

Brent: Absolutely. Right. So this year—you know, fourth year of a newly elected president with President Biden—has usually been a positive strong year. The first year—when we think of—or so in an election year next year, right, we usually see that by and large that equity markets do well the year of the physical election. So let's jump to 2025—has also usually been a positive year. So by and large, I know it's a smaller sample size, but we've seen more positive, you know, with equity markets before and after elections than we have significant or material contractual.

Phil: Yeah, and I think, as you alluded to—this is always a small sample. If you're looking at 40 years of data, there's only 10 presidential elections. You should not invest on 10 data points. Another thing just anecdotally, you know, we've spent our careers talking to investors—often the market trades differently than people expect after an election, and even before an election, based on their political leanings, right?

So just remember that slide we showed in terms of timing markets, et cetera. It's about staying invested, and not trying to trade stocks on Washington. For example, Washington's been in disarray this year, and the stock market's up quite a lot. So if stocks just traded on Washington, I don't know think the stock market would be up this year.

Brent: That's right.

Amy: So, Phil, it wouldn't be our monthly update if we didn't talk about real estate in some shape or form. Let's turn to the commercial real estate world and the housing market. Will it ever get back to normal?

Phil: The answer is—eventually, yes. Everything gets back to normal, one day. But commercial and housing—residential real estate—are illiquid assets. It takes time for this to play out. This is not the stock market. So when you think about commercial real estate loans coming due—that takes years to play out when you think about the price declines in commercial real estate.

And then on the housing side, the issue we have on housing is just really limited supply. There is housing construction happening. Recently, we have seen homebuilder sentiment decline, which I think may speak to the fact that mortgage rates finally got to a level that even new homes are potentially becoming problematic. But you're still seeing construction. It's going to take time. People have to get used to the idea of higher rates potentially.

And that could be something that could drive people into the housing market. Also, of course, if mortgage rates were to fall. At this point, even a six handle on mortgages, you would think, could be a positive considering where we are, even though a few years ago, 6% seemed seemed astronomical. So it's going to take time.

I don't think either of these markets are going to feel back to normal for, you know, we're talking, well over a year—maybe multiple years.

Brent: Yeah. And, you know, certainly something that we're watching is that you have a lot of real estate that needs to be refinanced between now and the end of 2025. So you have some $1.5 trillion of CRE bank loans.

Phil: Commercial real estate.

Brent: Yeah, commercial real estate bank loans that need to be refinanced between now and the end of 2025. So there's going to be a lot of action in the commercial real estate market. It really just depends on the path of real estate, you know, and banks' willingness to lend and what that actually looks like. So there'll be some volatility, but certainly something that you and I are going to be aware of.

Phil: Yeah, it's just inherently a slow-moving train. But certainly, risk persists for some amount of time.

Amy: So it's not surprising we got a number of questions around the future of monetary policy since it factors into so many different areas of the economy. Phil, what's your thought on the future of monetary policy as we go into 2024?

Phil: Yeah, look, our base case is that the Fed's on hold, but I don't think they're in any rush to start cutting. The truth is inflation, particularly core, is still well above their target. Core inflation's double their target. It's 4%. So I don't think they're going to be in a rush to cut. I think that the market has swung pretty wildly this year earlier.

Brent: Overly optimistic.

Phil: Yeah, earlier this year—overly optimistic—thought the Fed was cutting this year, which always seemed pretty absurd, and then we swung the other way. Now we're swinging—so markets are a pendulum that swings. Usually, the truth is somewhere in the middle of that pendulum swing, but we don't think the Fed's going to cut quickly say, you know, first quarter of next year.

Likely, they want to see their interest rate hikes and tighter monetary policy feed into the economy on a sustained basis. That doesn't mean they want to keep rates high forever, but they're going to take time. That's the path in my view.

Brent: Yeah, and let's hope this time around, you know, economic conditions you know, are always going to drive where they ultimately stop. But let's hope this time around that we stop at the, you know, lower bound of Fed funds at some reasonable level and not get back to the zero bound, which is hopefully going to set us up for a more normalized future than sort of this, you know, boom and bust cycle of, you know, overly hiking, overly cutting and swinging economies around. You know, going to 0% interest rates for more than 8 years, you know, created the incredible environment that we saw in risk assets that hopefully we don't see again as it relates to that volatility.

Phil: Similarly, Chairman Greenspan going down to 1% prior to the financial crisis. Same thing—those very low rates have implications. I mean, the caveat to all of this is if the economy were to turn lower very rapidly, then the Fed will be forced to act—assuming inflation's continued to cooperate.

Amy: Phil, the amount of credit card debt for Americans just hit the $1 trillion mark, but at the same time, consumer spending remains elevated. Where does all that factor into the economy's future?

Phil: Yeah, the person that asked the question's right. Credit card debt has skyrocketed. You started to see it really accelerate last year when gas prices accelerated. There are large swaths of our population that are living paycheck to paycheck. And when you have inflation, what do they access? They access their credit card. You are seeing credit card delinquencies rise—really only back to pre-pandemic levels. Credit card delinquencies fell to a very low level because there was so much cash on balance sheets.

So you are seeing revolving credit usage go up. But you also still have low unemployment. So as long as the labor market hangs in there, the consumer can continue to spend, and you still have wage inflation that's now above price inflation, right?

So by and large en masse, there's going to be consumers that are struggling, for sure. En masse, the consumer can continue to spend if the labor market hangs in there. It's all about the labor market. If the labor market weakens, then yes, credit cards are going to be used even more. Credit card delinquencies are going to go up even more, which is what you expect in a recessionary environment.

For now, the consumer balance sheet is still okay. But certainly there are some cracks forming, and credit cards are one of them.

Amy: Well, Brent, Phil, thank you so much for answering all of those questions. On behalf of all of us here at First Citizens, I want to thank you all for trusting us to bring you this information. That's something that we never take for granted here.

We will be back again next month with our 2024 market outlook. That's something we do at the end of each year and talk about headwinds and tailwinds for the year ahead. We'll be sending out information for that update in the coming days.

In the meantime, we hope you and your family have a wonderful Thanksgiving holiday, and we will see you back in December to wrap up 2023.

Making Sense Outro Slide

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