Making Sense: September Market Update

Amy: Hello, everyone. I'm Amy Thomas, a strategist here at First Citizens Bank. I'm joined today by our Chief Investment Officer, Brent Ciliano, and Director of Market and Economic Research, Phil Neuhart. Today is September 27, 2023, and I want to welcome you to our monthly Making Sense market update series.

Before I turn it over to Brent and Phil, we did receive a number of questions throughout the month. We'll try to answer as many as we can during today's discussion. If you have a specific question about your financial plan, please reach out to your First Citizens partner.

Also, just as a reminder, the information you're about to hear are the views and opinions of only the authors at the time of recording and should be considered for educational purposes only.

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

Brent: Well, thank you, Amy. Good afternoon everyone. Hope all of you are well. Phil, September is certainly living up to its historical reputation for seasonal volatility. We have a union strike. We have a looming government shutdown on October 1st without a continuing resolution. We have market participants that are finally coming to grips with potentially higher-for-longer rates and core inflation that's just too high for the Fed to declare a mission accomplished. A lot to cover this month. So, Amy, let's jump right in.

So expectations coming into this year, Phil, were that significant monetary policy was going to really crimp growth. Both here and abroad, and you can see expectations for the world coming into the year 2.1%, Phil, versus a historical, a long-term average of 3.4%. US 0.4% growth this year expected coming into the year, long-term average 2%. The good news is that both US and global economies have been far more resilient than expectations coming in. So right now, world growth expected 2.7%, US 2%—basically, Phil, right on the long-term average. But here we are again, coming into the fourth quarter and the expectations for 2024 is that, again, significant monetary policy tightening will crimp growth both in the United States and abroad, and you can see expectations for growth in 2024 calling for a significant slowdown in the US 0.9%. In the world, a little bit more balanced 2.6%. Certain pockets and areas, the Eurozone in the UK—after thinking that inflation was really going to take hold there—expectations for growth in 2024, actually better than expectations were coming into last year.

So again, broadly, an expectation for a slowdown in growth, both here and abroad. When you think about the United States more specifically on the next slide, Amy, US economy is slowing, Phil. And what we're looking at here, the gold line is manufacturing, the gray line is services, significantly slowing from their highs that we saw, Phil, back in 2021. And you can see manufacturing specifically in contractionary territory, services flirted with contraction, but still solidly in expansion territory. Readings for August, Phil, for both manufacturing and services ticked up. Have we seen the bottom in manufacturing and services? I think time will certainly tell. But this is one of the headwinds for the Fed as we're thinking about rates policy. But certainly slowing growth within the United States.

One of the reasons for that—on the next slide, Amy—is, Phil, what you and I have been talking about in, geez, almost every Webex, is very significant monetary policy tightening. What we're looking at here is every hiking cycle post-1982. The gold line is this current cycle. And what we can see, Phil, is that this is the one of the most significant hiking cycles that we've seen in the last 40 years. We're now sitting at a Fed Funds level between 5.25 and 5.5% from where we were back in March of 2022 at 0 to 25 basis points. So a significant movement. And I think what most listeners are thinking about is, "Well, geez, where do we go from here, and where are expectations?" So the Fed released this month their statement of economic projections and calling for about another 25-basis-point increase in fiscal 2023. A little bit of a change as it relates to 2024. They brought down their expectations for rate cuts from about 100 basis points down to about 50 basis points. So that's, you know, again, what's been causing a little bit of the market volatility in both equities and fixed income. Market participants don't necessarily agree. Right now, we have a less than a 40% probability of another rate hike in fiscal 2023, and expectations for cuts next year don't see the first cut really happening until July of next year. So, changing expectations for both market participants and the Fed.

Phil: So an aggressive Fed, and in September we had what has been coined the hawkish pause, and, you know, why is that? Well, it's inflation as we flip ahead. So Consumer Price Index overall is the gold line here peaked at 9.1% June of last year, has fallen precipitously, but you'll notice that little uptick. What is that? That's gasoline prices. And we've seen the price of crude continue to rise, and gasoline prices, we'll show in a moment, are a challenge.

If you look at core inflation, some of that underlying inflation Brent referred to, so this excludes food and energy. And when we talk about core and stripping things out, it tends to annoy consumers. Because we spend money on energy and food, right? But the Fed is trying to find underlying inflation.

You'll notice core inflation has deteriorated as well, but remains well above the Fed's target, is actually above headline. So why is the Fed sounding pretty hawkish in their most recent summary of economic projections? Well, it's because of the underlying inflation.

Digging in more on that concept of underlying inflation, let's look at the supercore. So if just removing food and energy annoys you, this is really going to annoy you. Right? So this is essentially core services excluding housing, and it's a measure that the Fed watches and market participants watch, which is why we're showing it.

It has fallen, but you'll notice it's around 4%. That's double the Fed's target. So even after stripping out housing, you're double the Fed's target, which is why we have been in the camp of higher for longer in terms of the Fed Fund Rate for some time. And the market is finally moving there and has been a huge driver of volatility in both fixed-income and equity markets.

So gasoline prices really quickly on the next slide. We have risen. Right? And that is impacting CPI data. What you'll notice is we are, thankfully, well below the July 2022 peaks, but certainly above where we have been of late. And if you're watching the price of crude oil, there's certainly potential for continued upward pressure in terms of gasoline prices. This could really throw a wrench in things when you think about headline inflation because, yes, the Fed might focus on underlying inflation, but they will not ignore headline inflation.

So, the rise in crude oil prices of late, coinciding the timing of it, was really unfortunate in terms of markets. So when we look at those expectations of inflation, this is consensus estimates of overall inflation. Right? And you could see, of course, the gray lines, the actual results, we've fallen pretty precipitously. The gold bars here, of course, are expectations going forward. And the expectation is the inflation will continue to moderate, but you'll notice nowhere here is it at 2% flat, which is the Fed's target. This is going all the way out to the end of next year. So the idea being that inflation's going to be here to stay. And if anything, the gasoline prices, looking at estimates like this, there might be some upward bias to these if gasoline prices sustained, remain elevated. So, some concern there, but nonetheless, underlying you would expect inflation to continue to moderate, and we do certainly hope so.

Brent: Yeah. And certainly, as you highlight, the heavy lifting has been done from June of last year to now. But I think whether it it's food prices, whether it's energy prices, you're likely to see variability and not a straight line down. So that little, you know, fish hook that you showed up, we're likely to see a little bit more variability in headline, and I think you're also going to see some variability in core as we get to the Fed's ultimate target. But I think you're clearly highlighting here, Phil, that consensus expectations are not at the Fed's 2% level even by the end of next year, so there's more work to do.

One of the, on the next slide, Amy, one of the tailwinds, I do believe though for inflation continuing to go lower or move lower is global supply chains. So, Phil, when's the last time we've seen in the financial news media or the media talking about global supply chain pressures? We really haven't seen it. So we thought it made sense to bring it back, and what we're looking at, the chart on the left, we're looking at the Federal Reserve Bank of New York global supply chain pressure index, which looks at things like freight rates, delivery times, et cetera, et cetera.

Phil: Backlog orders.

Brent: Backlog orders, exactly. And you can see, like, that move up that we saw in the pandemic—just incredible, incredible pressures in the global supply chain. But we've seen significant abatement in global supply chain pressures. And now we're actually at a level below the long-term average. So some of those supply chain pressures that were causing concern, causing higher prices during the heights of the pandemic, have certainly abated. And when I look at the chart on the right, which is one of the nuances within that global supply chain pressure index, when I look specifically at freight rates, we are now round-tripped back at basically long-term levels for shipping and freight rates. So that's a good thing to see and hopefully that continues.

Phil: And this is good news. I mean, if you go back 18 months ago, when we were on the road, the number one complaint from business owners, from our clients, was supply chains. Now the number one complaint is labor availability. Speaking of which, I think you're going to touch on the point.

Brent: Yeah, on the next slide, Amy, let's talk about the labor market. And, Phil, we've been talking about the labor market every single Webex for countless presentations. And it's been sort of that bastion of resiliency in our economy, and it continues to be that bastion today.

We are starting at the margin, though, to see the labor market starting to loosen up. When we specifically look at non-farm payrolls for the August print, we came in at about 187,000 jobs, better than expectations of 170,000. July did see a revision from 187,000 for July down to a 157,000. So a little bit of a loosening in the 6-month moving average now sitting at about 194,000. Go back a handful of Webexes. It was 300,000, then it was 200,000. Now we've dipped below that. Good news is we're still above that roughly magic number of about 100,000 jobs a month needed to keep the unemployment rate from ticking up. Though we did see this time around, the unemployment rate go from 3.5% up to 3.8%. So at the margin, labor market's still strong, but starting to loosen up.

Phil: And that moving unemployment rate, a lot of that was due to an increase in participation, which we'll get to in a moment is obviously good in terms of potential loosening of the labor market.

Brent: Another indicator that's showing that the labor market, Phil, is loosening on the next slide, Amy, is job openings per unemployed person. And you can see that huge move up that we saw this year and last, where we saw almost two open jobs per unemployed person, which was massively above the long-term average, has significantly moved down and we're now sitting at about one-and-a-half job openings per unemployed person. Still well above the long-term average, but that's about a 25% move down from the highs that we saw.

So again, signs at the margin, Phil, that the labor market is loosening up, though, to your point, when we're out in the market and we're talking to small and medium-sized businesses, that is still one of their biggest concerns is finding qualified labor, so.

Phil: Right. I think for those businesses, even if it's loosening on the margin, look at this chart, look at where we are versus the history of this chart. So it's still incredibly tight. Even if it's a little bit better than where we were, we still have a structural problem in this country in terms of labor availability.

Brent: Yeah. And one of the things on the next slide that is a more recent thing that's been in the headlines is the screenwriters strike. Well, thankfully, we've got a little bit of resolution there. The UAW and strikes there. What we wanted to show is, okay, well, from a union worker specific point of view, compared to total, total private employment, what does it actually look like? And right now, total union workers as a percentage of total private employment is only sitting at about 6%. You can see on this graph how that's changed from the mid-80s all the way to now. Union workers as a percentage of labor forces shrunken significantly. Still, with the writers' strike, we're likely to see that come into non-farm payrolls. If we can't get resolution to the UAW strike, again, we believe that would be a transitory impact on labor and not a more permanent thing.

Phil: Yeah, so while union is certainly a small percentage of the overall workforce, I do think what we're seeing in terms of strikes across industries is indicative of the issues in the labor market today. There's a reason that wage inflation is still at 4.3% when price inflation is only at 3.7%. Well, that is because there is strife within the labor market. It's a tight labor market, workers have more power than they have in past cycles, and that is finding its way into things like strikes and even labor outside of union.

So, back to the consumer and their spending, the good news in the US is if people have jobs, they're going to continue to spend. Right? So that tightness of the labor market, you can't overstate how important that is for economic growth. Here we're showing personal consumption on both goods and services year on year. Services spending at 8.26%, well above that 20-year average you see in the box there. Goods spending has moderated and is actually below the 20-year average—still positive, but moderating. What we've seen, and this has played out now for a good year-and-a-half, is we had a lot of goods spending during the pandemic that has shifted to services spending. If you've been to an airport lately, if you've been to a restaurant lately, you're seeing that firsthand. The consumer is what's keeping this economy afloat. We showed ISM services. We showed ISM manufacturing. They're showing two different stories. Consumer is really the ballast for now in the economy.

So we get a lot of questions as we flip ahead in terms of the consumer balance sheet. It's well reported that there are a lot of excess savings coming out of the pandemic. Right? And those savings have dwindled.

So what about the balance sheet from a debt service perspective? So what we're showing here is the debt-service ratio. This is the ratio of total required household debt payments to total disposable personal income. What you'll notice is it's basically back where we were pre-pandemic. Those big spikes down during the pandemic, remember there were a lot of checks hitting people's accounts from the government that increased disposable person income and distorted the data, so just draw a straight line across in your mind. The story here is the consumer, even with higher interest rates, as of today, is still looking pretty healthy from a debt-service ratio. Look at where we were before the Great Financial Crisis, '07 and earlier, incredible debt burden on the consumer. We had a paradigm shift. The financial crisis, as crises will do, woke people up, and we have seen a shift, and we're still there. The question's going to be, we'll be watching this data closely, is does this change? Right? We know that people are hesitant to list their home because they have low mortgage rates. Well, eventually, people are going to have to list their home. People are eventually going to have to get a new car, right? Credit card debt. So eventually, do we see a move up here in a higher-interest-rate environment? We have yet to.

Brent: Yeah, and certainly obviously the denominator in this is incredibly important. Your point fiscal stimulus, the wage inflation, the wage growth that we've seen, the employment picture, has allowed the debt service for households to be, you know, in a very controlled, at a very controlled level. Again, if we start to see some loosening in the labor market or wage growth starts to moderate, you can see that ratio adjusting relatively quickly because of the strength of—or the lack thereof—of wages. So we'll just have to wait and see.

Phil: Right, so another topic on consumer's mind is on the next slide, and that is student loan repayment. What you'll see, as we've seen a significant spike in repayments, what's interesting is this spike actually precedes when the payments are due in October. What this indicates is—it's something that's actually a little bit positive—which is consumers still have some excess savings, and they were paying down debt ahead of interest accruing. Right? But nonetheless, we know that this is a multibillion-dollar weight on consumers. Seeing estimates something like 0.2% out of GDP growth annually, just because it's another payment on, what is it 43 million?

Brent: Yeah.

Phil: 43 million consumers. So this is something worth watching. We've already started to see the impact of it, and it will dampen consumption to some extent. How much? Time will tell. So the number one question we get is on the next slide, are we, are we entering a recession or not? We, amazingly, we've gotten this question since probably the day the Fed started hiking.

Brent: Twelve times a day.

Phil: Yeah, so a year-and-a-half now, and the truth is the economy's been far more resilient than we expected, and that really, I think any professional economist expected. So what we show here is the balance of risk, and we've shown this for some time. Let's just go through what we see to avoid recession and recession. So what are the strengths right now in the economy? We covered the labor market—incredibly tight, still very resilient. We are a consumer economy. The labor market supports the consumer. The consumer is spending on services, the third point here. The service economy is really the strength of the US economy today. Then the fourth is residential construction. Let me spend a second on this. So we've outlined in previous webinars that people are very hesitant to list their home, right, because they've locked in low mortgage rates. That is keeping the supply of homes very tight in the resale market, which is, of course, pushing new construction. So we had seen housing starts at pretty healthy levels, sort of 2019, even above average 2019, levels. Homebuilder sentiment had improved. Well, we start to see a turn in that in the most recent data over the last 2 weeks. Homebuilder sentiment fell, housing starts fell and new home sales fell.

Now, 1 month does not make a trend, but I think when you start to see it—and homebuilders even cited this in their survey—when mortgage rates went over 7% on a sustained basis, that seems to have had an impact. So residential construction is still a positive because the housing market is so tight, but there is something going on there. It's certainly worth watching that slowdown that we saw last month.

Brent: Yeah, and if I take the glasses-half-empty view on that, which fits my personality, let's talk about the probability for a recession over the next 12 months. We highlighted very deeply where we are as it relates to monetary policy, one of the most significant monetary policy movements that we've seen in more than 40 years. And again, as we've talked about many, many times, that monetary policy works with long and variable lags, and we don't think that full impact of those lags have been felt by the economy. I think that's why that's worked into some of the projections for fiscal 2024 that we showed on the very first slide.

Still waiting for that to hit, in real terms, our economy. We talked about manufacturing being, you know, still in contraction. We've seen a little bit of a move up, maybe we've seen the bottom, maybe we haven't. Time we'll certainly tell. But manufacturing is critically important to the US economy, and that's in contractionary territory. We haven't really talked a lot about it, and I know that we're going to talk about fixed income when we get to the market section. We still have an inverted yield curve. We've seen that inversion moderate from more than 100 basis points of inversion to right around 50-ish basis points of inversion. So lightening up a little bit, but still fundamentally inverted, which is a harbinger potentially—at least historically—of a recession. And one thing that you just talked about, residential construction, commercial property market has certainly seen material selloff. It's more of a trifurcated market. But I think about industrial, commercial property or multifamily versus office space. Really the office space is where we've seen a lot of the pain as it relates to commercial property prices. Whether or not we'll see any type of abatement anytime soon, too early to tell, but certainly a lot of pressures as it relates to prices in the commercial property market. Again, probability of recession, we still think that it's, you know, close to that 60% over the next 12 months. A lot of balance here.

So why don't we shift gears, Amy, and let's move forward, Phil, and talk about a market update, and jump right in and look at the chart on the left. Despite 6 out of the last 8 weeks where the S&P 500 has actually produced a negative return, and we'll see so far this week that might be, you know, the seventh out of 9 weeks. Despite that, Phil, looking at that very first bar, set of bars, you know, US equities still positive more than 12% year to date despite that volatility. International developed markets, updating this on the fly, up a little bit more than 6%. Emerging markets still in positive territory, up about 2%. But as we talked about, as market participants have come to terms with a higher-for-longer rate environment, fixed income—both taxable bonds and municipal bonds—are now in negative territory year to date, and we're seeing continued volatility in both taxable and municipal markets over the last several weeks. Specifically, as we look at the chart on the right, where have US equity returns, when I look at the style box, been year to date? Well, it's been a growth-led rally. We've talked about the Magnificent Seven and what they've done year to date. So large-cap growth outperforming everything. Interestingly, though, Phil, when I look post the S&P 500 high on July 31 of this year, between July 31 and today, value—both large and small—has outperformed growth by about 2%. So maybe we're starting to see a little bit of a regime change taking hold as it relates to that balance within equity markets.

On the next slide, Amy, what I really want to focus is, Phil, on that chart on the right. Year to date, we've seen two drawdowns. One in the earlier part of the year, about an 8% peak-to-trough drawdown, and most recently, from July 31st to today, a little bit more than 6% drawdown. Interestingly, we've talked about this in the past, Phil, the average intra-year drawdown for the S&P 500 post-1990 is 15%. We're not even at half of the average drawdown. So while we certainly don't like to see, you know, equity markets sell off, the volatility that we're seeing is beyond normal, and we would expect, again, as we talked about seasonal volatility in September, it's usually a volatile month for both equities and fixed income. But I think the important thing on the slide is that we are still more than 21% above the October 12th low that we saw on the S&P 500 of 3577. So again, volatility that we expected to see—nowhere near the average entry or drawdown.

Phil: So let's turn to—that's price—let's turn to earnings for a moment here. If you look at consensus earnings expectations, this is analyst bottom up. So what this is—let's say there's an industrials analyst, that person covers 15 companies, they have estimates for their companies. You sum those up for 500 companies in the S&P 500. 2023 really muted earnings growth, expected, we still have a couple quarters of earnings results to come: 1.1% growth. Consensus is pretty optimistic on next year: 12.2%. You might say overly optimistic, but certainly optimistic going into next year. The average growth for context is 7.6% since 1950. So we're in a situation where earnings are expected to move up from here. Right? We'll talk about our price start more in a moment, that does have implications, of course.

Importantly, operating margin, which is a very important measure—peaked sort of late '21, early 2022—fell pretty precipitously. You see this on the right side, estimated forward margin, but has started to tick up. That is really an optimistic thing to see and until the recent sell-down is one of the things that people like us would point to in terms of why the market continues to move higher was an improvement margin. This is very important to watch, especially with the move in things like energy prices, right, and wages. Do margins, have margins really bottomed? If they have, that should be a good indicator for the market.

So let's turn to our S&P 500 price target. We last updated this a quarter ago, updating it this quarter as well. We generally update this every quarter or two. It is a forward 12-month S&P 500 price starts, so we're looking out 12 months. We are updating our base case to 4,650, that is up about 7.6% from Friday, September 22, level. And you can see the bear and the bull cases here as well in those price changes. Just to give you some context. What does each of these scenarios really mean? Well, in the bear case, we're assuming some pretty material downward revisions to the next 12-month earnings expectations and then below-average earnings growth in the year following that and multiple contraction. Well, what is multiple contraction? Well, priced earnings multiple. It's the price you're willing to pay for a dollar of earnings. If that goes down, it means the market's cheaper. That's the bear case.

In the base case, we have modest downward earnings revisions in the next 12 months, and then about average earnings growth in the year after, so it's pretty conservative still, with the multiple remaining relatively flat, and you could see that result at 4,650.

Bull case is upward earnings revisions, better-than-average growth in the following year and that multiple expanding, in other words becoming more expensive—and that's the bull case. We all cheer for the bull case, right? But this is the framework in terms of, in terms of how we are thinking about the stock market.

Brent: So let's shift gears away from equities, and let's talk about fixed income. What we're looking at here is the treasury yield curve, so short rates all the way through the 30-year treasury. The gray line on the bottom is the yield curve when we came into this year, and the gold line is where we are today, and you can see a very significant parallel shift in the yield curve from the beginning of this year to now. A little bit lumpy at certain key rate durations, but by and large, a pretty significant parallel shift in yields across the entire curve. Over the last 3 to 4 weeks, we've seen more of a bear steepener, which basically means the short end has been predominantly anchored, and belly and out, longer rates have gone up, and yields have risen, and prices have gone down. Just an incredible move across the board.

And when we look at the next slide, Amy, and we think about not just treasury yields, but we look across all fixed-income sectors—look at where we were, Phil, when we came into last year into 2022. Yields across the board were incredibly sanguine and low, and the opportunity within fixed income, if we believe that current yield to worst is an expectation for forward returns, was very, very modest. Fast-forward to where we are now and the significant movements, and I'm going to update this on the fly when I look at the aggregate bond index sitting today at about 526 as of Friday of last week. Today, it's sitting at about 537. So significant change from where we were coming into 2022. On the municipal side, you know, sitting at 406 on Friday of last week, 417 today. Tax-equivalent yield gets you to almost 6.5% if you're in the 35% tax bracket.

So significant opportunity across various fixed-income sectors—both taxable and municipal. And, again, we put out a piece not too long ago as it relates to yield to worst being a pretty good predictor of forward expected returns over the duration horizon of these fixed-income sectors. So again, while we've seen price volatility as yields have risen, opportunity going forward across various fixed-income sectors is quite robust.

So one of the things that we wanted to highlight—and we've showed this before—is we are now, as of today, in the third year of fixed income producing negative returns. And what we're looking at is the Bloomberg US Aggregate Bond Index, which is one of the more preeminent and globally accepted indices for broad US fixed income, both corporate and governmental. And what you can see here is that those last three bars, 3 consecutive years of negative returns, much of which done during this tightening of monetary policy. What I think is interesting is that the average intra-year drawdown over time has only been about 3.5%.

Phil, look at 2022. Intra-year drawdown of negative 17%. It's almost more than a five standard deviation event relative to long-term averages. Again, time will tell whether or not we end the year with a negative result, but when you look opportunistically, when you've had periods of time when we've sold off, subsequent years have produced positive returns. Let's throw some salt over the shoulder and knock on wood that this year ends up positive, and then forward expected returns in 2024 and beyond work out well, at least historically.

Phil: Right, so for fixed income, government finances always matter as well when you think about level of yields. And this is a big topic right now in all of our minds because of the potential government shutdown. There's a huge debate around federal debt. So US federal debt as a percentage of GDP is essentially back at World War II levels and projected to move higher. This is sort of the table setter of why it's such a topic on people's minds. You can see really the hockey stick higher with the pandemic, right? So we were already marching higher, and the pandemic really drove federal debt as a percentage of GDP materially higher. Why is that potentially a problem for the US government? As we flip ahead here, on the left side, we're showing federal debt maturing the distribution by year. The next 3 years, 49% of outstanding federal debt matures, 49%. Now think about what interest rates have done. Well, that is the rate at which the US government finances their debt.

So what is that driving on the right side? One, the gold line, net interest cost as a percentage of tax revenue has skyrocketed, right? Paying interest as a percentage of that tax revenue is much more expensive for the government. Think about you as an individual. You have a low mortgage rate. You have to move for some reason. You have to refi into a higher mortgage rate in this new home. Your expenses go up, right, as a percentage of your salary, same thing for the government. The weighted average cost of that marketable debt, the gray line, has also risen. Now it hasn't risen as much as you might think, but why is that? Because the Fed, you know, they issued a treasury at sub 1% in 2020. That does not mature until 2030. So there's still a lot of debt waiting to mature, but these lines should be moving higher as bonds come due and the federal government has to refi, essentially, into higher interest rates.

Brent: Yeah, I mean, it's certainly been a topic not only today, but as we get into 2024 and a presidential election, all the fun that you and I are going to have talking about that election. Certainly governmental finances and our debt obligations and interest costs and burden certainly is going to come up in debate, so it's certainly something that will be on not only voters' minds, but our government.

So let's shift gears, Amy, and let's talk a little bit about market cycle and where we are. So what we're looking at here, the gold line, is the upper bound of Fed funds, and we take this all the way back over the last 23 years. And then we've got the 3-year and 5-year treasury are the black and gray lines, and what we really wanted to highlight is maybe where we are in this cycle, right? So July, we had, you know, a rate hike. Maybe it was the last one. Maybe it's not. But when we go back and look at the three other environments that we were in, where rates rose either and then plateaued, you can see what treasuries and fixed income has done across the board. By and large, once we get to that last hike, let alone the next or the first cut by the Fed, you start to see yields fall and bond prices rise. So whether or not we're at a plateau and, you know, we're going to sit here and be higher for longer, time will certainly tell, but ultimately, when you think about expected returns for fixed income, as you get to that last hike and then ultimately that first cut, you end up getting to an environment that's very pro for bond prices.

So when we look at the next slide, Amy, and we think about expectations, the gold bar is, you know, basically a cash proxy 3-month T-bill. The gray line is the US Aggregate Bond Index post, if I look at the 3-year returns, Phil, following the final interest rate hike for the Fed, you can see that intermediate and longer-duration bonds have had produced a better total return than sitting in cash, and we're quite often asked, "Hey, should I be sitting in cash and yield it and getting these wonderful high rates?" We believe that that is, you know, certainly a balance as it relates to financial planning. You certainly want to make sure you have the right amount of cash to take care of short-term obligations. But when you're thinking opportunistically about what expected returns might be over the next 3 years or more, duration might be your friend. It's been volatile of late, but we're looking out longer term. We think that longer duration certainly has a role in portfolio.

Phil: And for those investors who aren't really worried about the total return, just worried about the coupon, right, that there is an option to lock in yield at these levels. You can lock in yield for 5 years, maybe more, at high levels, and when the Fed Funds Rate comes down and cash is not yielding as much, you are still generating that yield within your fixed-income portfolio.

Brent: Absolutely.

Amy: Brent, Phil, thank you so much for jumping into all of that information. Lots to consider in both the markets and the economy, as always. Just a reminder to those who are interested in staying informed throughout the month, we do have several publications available, including weekly videos, poignant commentaries throughout the month. If you're interested in getting that information sent straight to your inbox, you can subscribe using the QR code on the screen or visit FirstCitizens.com/wealth.

Brent, Phil, let's jump into questions. The temperatures and the leaves may be starting to fall, but mortgage rates are not. What do mortgage rates above 7% mean for the housing market?

Phil: Yeah. I think, um, we're starting to see that impact. I touched on it quickly, but I'll dig in a little bit more. One, in terms of the resale market, it's basically locked up, right? I mean, there's just not much supply. People are very hesitant, of course, to list their home and be forced to go into that higher mortgage rate if they're at 3% mortgage going to north of seven would really hurt. So it's locking up the resale market. In the new-home market, it is pushing some people to the new-home market, and there's homebuilders doing things to subsidize rates, bring down rates in terms of lending, but we are seeing implication. Right? We're seeing homebuilder sentiment fall. We're seeing housing starts fall. We're seeing new-home sales fall. So it's not that it's—and look, housing's always geographically specific. In your metro area, it might look very different—but it's obviously having an impact in the housing market. We often hear people say, you know, are higher rates, you know, are higher rates really feeding into the economy? Well, just look at, look at the housing market. It's clearly having implications. Now, supply is so tight that home prices have hung in there. So if I told you all of that, you would expect home prices to be falling. They are not, and the reason is there's just no homes for sale. So in terms of net worth of consumers and the value of homes and the wealth effect that it has on people spending, that has not been it to this point. But look, north of seven, there are implications. And by the way, the Fed knew this when they hiked rates this rapidly, that the housing market is one of the places that would feel it the most, and it is starting to see that through these distortions.

Amy: Phil, speaking of the Fed and interest rates, what is the chance the Federal Reserve starts cutting interest rates by the end of first quarter of next year?

Brent: Yeah. Maybe I'll jump in on that one, Phil. Right? So as we were chatting, you know, earlier, that if I look at the sort of the summary of economic projections that the Fed put out, you know, they have shifted their expectations from 100 basis points of cuts in fiscal 2024 to 50 basis points. They don't, they don't talk about the timing necessarily of when those cuts are going to occur. But if I look at Fed fund futures pricing from a market participant perspective, right now seeing rates being cut in the first quarter of 2024, quite a low probability, sub 25% probability of a first rate cut in the first quarter of next year. You really, Phil, have to go out to July of 2024 to really see a more material expectation for the Fed to cut rates. So it's kind of safe to assume—again if market participants are right—that you won't see rate cuts in the first half of next year, and it might likely be in the second half of 2024 where you would see the first rate cut or more in that back half.

Phil: And if we bring that back to markets, what we've seen over the last couple of months—and really accelerated with the most recent Fed meeting—is both fixed-income and equity markets coming to terms with the concept of higher-for-longer rates. We've seen that move in yields. We've seen the stock market sell off. Earlier this year, the market Fed funds futures just consistently priced Fed cuts that we felt were far earlier than likely. Well, the market's finally starting to come to terms with that. Fed funds futures have been pushed out, but that has had real implications for both risk markets and fixed-income markets.

Amy: So let's turn to the yields a little bit. Let's talk about whether or not treasury yields can continue to march higher from here.

Brent: Yeah. So the answer is, sure they can. Right? And we've seen that over the last handful of weeks to your point, Phil, as market participants are finally coming to terms with higher for longer. We've seen yields back up. And, you know, we're sitting, let's just say for the 10-year treasury around four-and-a-half-ish as of the time of this recording, could they materially move higher from here? Sure, they could. Will they move materially higher from here? Time will tell. You know, do we see the 10-year, you know, treasury at 6.5%? Probably not. Do we see it higher from here, maybe 4.75, 5%? Potentially. It really depends on a number of things, and we talked about earlier where core inflation is supercore. We're going to need to see an abatement in energy prices, food prices. So the Fed is just not yet comfortable with poor inflation, and a trajectory of where it's going at the rate that we need to see for them to, you know, basically say mission accomplished. As such, we're seeing a lot of variability in yields, and I think we're going to continue to see variability both up and down in yields until we get a better and more clear view on the path of inflation from here, and we're just we're just not there yet from an economic data point perspective.

Amy: We talked about the strikes a little bit, but we did get some questions on it. So what are your thoughts on the uptick in strikes and broader implications for the economy and the markets?

Phil: Yeah, so look, as we look near-term, UAW is still on strike. If that persists—and especially if it deepens in terms of the number of individuals striking—that will have implications in terms of labor market data, potentially consumption data. So we are going to see implications for consumer spending, et cetera. But we did show that, and we're showing it here, the percentage of union workers in terms of private labor market has fallen quite a lot. So it's not enormous persistent hits. It's more transitory in terms of actual economic growth. But for me, at least, it's more about the broader story—that what we're seeing with the Screen Actors Guild or the screenwriters or the UAW is just a symptom of what's happening outside of union labor, which is the labor market's really tight. We hear this from our clients all the time. They are having to pay up for both skilled and unskilled labor. That labor is not union, right? We, this is not just about unions. This is about fact that in a tight labor market labor has more power, that puts upward pressure on wages, which has implications for the Fed, which then has implications for the markets. So I think it's beyond just the story of UAW. It does go beyond that. There are implications to the broader economy.

Brent: Yeah. I think that's spot on, Phil and, again, employees in this market still are in control. And again, the feedback mechanism specifically as it relates to markets, you know, higher wages for longer does feedback into corporate earnings and profitability. So until we kind of get that balance, we're still likely to see that feedback mechanism still come into play.

Amy: Well, thank you both for all of the information and for answering some questions. And thank you for everyone for watching. We'll be back again next month and bringing you another update in October. Thanks so much for being with us, and we look forward to seeing you next month.

Making Sense In Brief Outro Slide

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