Making Sense: August Market Update

Amy: Hello, everyone. I'm Amy Thomas, a strategist here at First Citizens Bank. Today's Thursday, August 29th, 2024. I'm joined by Phil Neuhart, Director of Market and Economic Research, and Brent Ciliano, our Chief Investment Officer. I want to welcome everyone to our Making Sense: Market Update series.

We received a number of questions on our FirstCitizens.com page. If we're not able to answer your question, please reach out to your First Citizens partner or connect with one at FirstCitizens.com/Wealth. As always, 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. This information should not be considered as tax or legal advice.

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

Brent: Great, Amy. Well, thank you so much and good afternoon, everyone. Phil, I cannot believe it. The summer is basically over. You don't look tan at all. Do you ever take a vacation? Do you ever stop working?

Phil: Not often enough. I need to talk to my manager about that.

Brent: You should. You should. So we've got a lot to cover today. So why don't we jump into it, Phil? So from an economic perspective, we're going to talk about broad US growth and the trajectory from here. We'll talk about interest rates, inflation, all the normal stuff. We'll talk a bit about monetary policy. We'll talk about the labor market and certainly the consumer. And then we'll kind of try and sum it all up.

We'll then jump into markets like we normally do. And the markets continue to be volatile. So we'll talk a little bit about the direction of markets from here, both equities and fixed income. And then we'll talk about some potential headwinds and maybe some tailwinds as well.

Phil: Absolutely.

Brent: So let's jump in, Amy, and let's talk about the economy. And let's start, first of all, with US growth. What we're looking at here, Phil, is endless expectations of growth—real GDP growth in 2024. And you can see when we came into the year, Phil, expectations were low, sitting at about 0.9%. And again, the thought process was that the most significant monetary policy in more than 40 years would slow growth. That long and variable lag would start to kick in and growth would slow. And it just wasn't the case and expectations continue to rise.

Phil: Interestingly, just this morning, we saw an upward revision to second quarter GDP to 3.0%. Personal consumption was revised up. So interesting that growth was even stronger than originally reported in the second quarter, which feels like some time ago now, but still tells you the path we were on.

Brent: Exactly. And now sitting at 2.5%. If we ended today, end of the year ended today, we'd basically be at the same level of real GDP growth that we had last year, 2.5% in 2023, sitting at 2.5% from 2024. Time will tell. We'll see where we finish up. Some of the recent data is important to kind of work in and see where we go from here. But again, much better than expectations.

So let's go to the next slide, Amy. Here's a new slide that we threw in here. I love when we put in new slides to kind of keep things fresh. What we're talking about here and what we're showing is corporations and their earnings calls and words like inflation and recession and the things that they're mentioning here.

The gold line is how many times executive leaders in those earnings calls use the word recession and how often they use the word inflation. You can see, the good news is both for inflation as well as thoughts of a slowing economy and recession, we're seeing companies and executive leaders talk less about those two things.

So I've got my fingers crossed, especially on the inflation front, that we'll no longer have to talk about inflation to the extent that we have in the past. And certainly as it relates to a slowing economy and everyone's fears that we are going to head into a recession, or God forbid that we are in recession. At least from a corporate executive leader perspective, it doesn't seem like we are. So again, good news on that front.

If we shift gears away from some of the largest companies on the next slide and we talk about our small-to-medium-sized businesses, what we're looking at here in the gold line is the NFIB Optimism Index. In essence, how optimistic or not small-to-medium-sized businesses are about the future.

In the blue line here, we're talking about the uncertainty index from the NFIB, how uncertain the future environment is for small- and medium-sized businesses in their operating environment. And what you can see in the gold line, it's hard, you have to look really close, we have a little bit of an uptick in optimism. So small- and medium-sized businesses are a bit more optimistic today than they were several weeks and quarters ago.

But I think, Phil, the one thing to take away here is look at the big move up in uncertainty. So maybe they are cautiously optimistic about the future, but by and large, whether it's large businesses or small businesses, a better picture than where we are several quarters ago.

Phil: It is. It's improving, but still interesting how optimism is below the pre-pandemic level. And we hear this on the road. Big companies, S&P 500 companies with large cash hoards, are feeling more optimistic than small companies who might be more reliant on debt, for example, loans. Well, rates are up. So you are seeing the more rate-sensitive parts of the marketplace a little bit more concerned. Maybe the recent decline in rates is what's improving optimism within small businesses, but certainly something we hear on the road. A lot more concern from small businesses than you might hear from the very largest companies in the US.

Brent: Yeah.

Phil: So you mentioned hopefully soon we can stop talking about inflation that day unfortunately is not today. Here we're showing headline and core consumer price index—core remember excludes food and energy. We're showing the year-on-year numbers which you hear reported in the press. They've trended lower, getting closer to that Fed's 2% target, not quite there yet.

But if you look at the most recent trend—and the reason you'll hear a lot of folks talking about how inflation really is approaching the Fed's target—if you look at the 3-month annualized, which are the dashed lines here, look how low it is. I mean, headline and core, you're at or below depending on the measure the Fed's target. So we have seen dramatic improvement recently. When you analyze those recent numbers, it's starting to feed in. This is why the idea that the Fed might be able to cut has really taken over, something we've talked about in recent meetings.

Speaking of the Fed, as we flip ahead. Right now, markets are implying, according to fed funds futures, four quarter-point cuts this year. Now you say, "Well, how four? There's only three meetings."

Well it might be that it's 50 basis points in September and then a quarter in November and a quarter in December or some other mix. But very high likelihood, of course, that the Fed's cutting September. The real debate now is around a quarter or half a point. We get more data from the PCE deflator. We get an employment report on September 6th. There's a lot coming out before that next meeting that may help to determine if it's a quarter or half point.

Brent: Yeah. And if we go out beyond 2024 and let's look all the way out, which would be hard, it's a little hard to do because things are so volatile and moving every day. Let's look out to where fed fund futures are pricing in rate cuts through 2025, end of the year 2025. And right now we are sitting at about nine quarter-point cuts through the end of December of 2025. That seems, I mean, certainly things have changed. From our lens, I would say we would take the under on that side. If we do see nine cuts, to me, that feels like something in the economy is broken and that we're either headed towards recession or in recession at that time. Again, a lot of volatility in this data and we've been all over the place. But at the end of the day, I think the most important thing is that the Fed is on a path to reduce rates. The real $64,000 question is really the velocity and how much they will cut when.

Phil: Absolutely. So the Fed is cutting. How might markets perform around that? Well, the key question is, is there a recession or not? So if you look at the average S&P 500 return from the date of the first cut, which we believe will be September 18th, this is data going back to 1979—so long-term data set. You look at the gold line. This is economic recession did not follow a rate cut. The market actually performs pretty well. So when you hear this sometimes in the press, really the issue is if a recession follows. And that's the blue line here.

Markets can perform if the Fed's cutting for good reasons. They're cutting because the economy is normalizing. If they're cutting because we have a recession, that's a different story. We do not have a recession in our base case. Most do not, which was very different a couple of years ago when most did. But obviously, risks are more balanced, but the economy still looks pretty strong. If the Fed's cutting, the market can still perform, assuming no recession.

Brent: What I like about this slide is that, again, even if we were to not have a soft landing like you would see in the gold line, and you do have something that—and a recession follows it—look 1 year out. So, you know, in the horizontal axis, we're looking at days since first interest rate cuts. So if I go out basically through that 1 year, we end up with more median observation, a flat cut. Or sorry—flat return—in the S&P 500 versus your volatility. So it's not like positive 20 or negative 20, depending on whether or not we have a recession or not. It's really flat.

Phil: Market sells down and then they can rally back as you see in that blue line. What about the labor market?

Brent: Yeah, so switching gears towards the labor market, we showed this slide last time. What we're looking at here is the unemployment rate, U3, going all the way back to 1960. And you can see a lot of variability in the unemployment rate through time. That blue dotted line is the long-term average. And you can see since 1960, the unemployment rate has been about 5.9%. We hit a multi-decade low back in April of 2023 at 3.4%. And you can see on that far righthand side, we've seen the unemployment rate move up almost a percent, about 90 basis points from 3.4% in April, 2023, to now in July at 4.3%.

So we've seen a rather material move up in rates, and the $64,000 question is where do we go from here? And consensus expectations for all of 2025 is still sitting at about 4.3%. And interestingly enough, in 2026, which seems way out there to be making those types of forecasts, down to 4.2%. So we might push back against that a little bit because if you go back and look across, run your eyes right to left, and you see any time we've had sort of these cycle lows, you've seen the unemployment rate move back up to a much higher level.

Now I don't think we're going back to the 2020 period of 14.8% unemployment or something that we saw post-The Great Financial Crisis but maybe something a little bit more like the early 70s or the early 2000s—where we went from a cycle low up back closer to average. So time will certainly tell. We'll get a little bit more about the labor market here on Friday, September 6th, which is also the first day of the NFL season, so that's great. So we've got unemployment data, or sorry, we get data on payrolls as well as kicking off the NFL season. We'll see where the data lies, but again, our belief is that we see a move up in this over time.

So looking at jobs creation, new payroll jobs growth has been robust. And you can see the highs that we saw back in 2021. And we're looking here at 3-month moving average. So not exactly just a given print, but a 3-month moving average. You can see we have been moderating lower in payrolls growth. And you would expect that coming, you know, out of the pandemic and the stimulus that we had both in the fiscal and monetary policy side. And we can see that we're sitting at a level right above the estimated breakeven rate.

So we're talking about, you know, that long-run unemployment. So the rate that we sort of need to kind of want to keep above so that we don't get back to sort of that more structural unemployment. But again, payroll creation remains strong. Expectations that we're going to see in September right now sitting about 160,000 jobs. We'll have to wait and see what that number looks like.

Another new slide that we haven't used and sort of looking at an alternative measure of job openings is the Indeed Job Postings Index. And what you see here is that, again, from the highs that we saw back in 2021, job postings have moderated lower. And again, the labor market is still strong, but we are seeing less postings of jobs. Still back above pre-pandemic level that we saw back in 2019. But again, moderating at the margin. So the labor market, by and large, is moderating and slowing. Not falling apart, but slowing at the margin.

Phil: Yeah, we're seeing that normalization from really what were extremes, where we had, what, two job openings for every unemployed person. That has come in. Hopefully, it's normalizing and not softening.

So speaking of the consumer who still has jobs, let's flip ahead. What are we seeing from a spending perspective? Well, we're still seeing services dominate spending. Goods spending is below the 20-year average currently, while services is above. That, of course, is a big reversal from what we saw during the pandemic era.

Speaking of that, let's flip ahead. If we break this apart and look at personal consumption—the share of consumption that is either goods spending or services spending—we see services spending as obviously dominant and moving even stronger in the US economy. There was a little point during the pandemic when we were all stuck at home that goods spending had a nice little rebound. And now we're back.

What's interesting is if you look at that blue line, services spending as a share of total consumer spending. It's not quite back to the pre-pandemic level. So there's still room to go, and goods is not either. So it is interesting that there's so much talk about the growth of services. Really, that's just a normalization from a distortion from the pandemic. But certainly we spend more, we think about the goods we buy because we hold those goods, but we spend more on services. Think about healthcare, education, you name it. Services is a big portion of what we do.

So let's talk about the housing market quickly. We've broken the housing market apart in every which way, whether we're looking at inventory, sales, et cetera. This month, and you feel free to go back to previous months, you can see different ways we've looked at it. We know that sales still remain pretty depressed, even as mortgage rates have come down recently. That might improve a little bit. We have seen inventory come up. So we're starting to see supply and demand come better in line. But we still have an issue, and that's home affordability.

So this is household income relative to income required to qualify for a conventional loan. And what you'll notice is—affordability for the median home buyer is very low. We're talking the lowest we've seen since, what, 2000, pre-Great Financial Crisis, 2006-type level. It's even worse for median renter or first-time home buyer. And why is that? Because the terms of those loans are often different. You're putting less down, et cetera.

Why? Rates are up and home price appreciation continues in this country. It's different by region, of course, but we are still seeing home price appreciation. If inventory starts to rise, hopefully that home price appreciation remains positive, but moderates. And if rates come down, that would also improve housing affordability. Right now, this is a huge challenge for first-time homebuyers.

So we talked about mortgage rates coming down, and we have seen that recently. Mortgage rates tend to track things like the 10-year Treasury and the 30-year Treasury. Those have come down, and we have seen on the other side, mortgage applications go up. Now a lot of those are for refinance, of course. But there is, it does show when you look at this chart, there's a reflection there. When rates go down, mortgage applications go up. This could be good news for the housing market. If rates continue to fall, obviously inventory is going to be the story. We need inventory to improve as well. It has started to, we need that to continue. But good to see mortgage applications turning up, still from very low levels, but turning up compared to where we've been.

Brent: Absolutely. So let's bring this home, Phil, and let's talk about it, sort of summarize. So the tailwinds and the headwinds broadly for our economy. So on the positive side, when we think about what we just covered, you know, service sector spending, which is a significant component of spending, but also consumer spending, a very significant component of overall real GDP, still fundamentally robust and growing at a pretty significant rate. And as you say, getting closer, right? So, you know, filling in that gap from where we were and getting a little bit better.

We'll talk about in a little bit corporate earnings and profitability. You know, very robust. Second quarter earnings season was really thoughtful. We'll talk a little bit about that more in a second where expectations are—not only for the rest of this year, but for 2025. And as you highlighted, 3-month moving average of inflation, whether I look at headline or core, looking much better. Again, we're not out of the woods yet. We still have a lot of wood to chop, but by and large, we are seeing a disinflationary trend, which is good to see, and certainly being reflected in the earnings releases and statements from corporations, which is good to see.

Interest rate cuts, we talked about that ad nauseam and where we go from here. It's not a matter of if it's really a matter of how much from here. I know we've just covered job gains, the overall labor market still robust. And while we've seen a move up in the unemployment rate, we've still seen limited layoffs. When I look at jobless claims and continuing claims, still at relatively low levels relative to history, and broad financial conditions are still robust. The equity market has done well, spreads remain still relatively tight historically. So overall, a lot of positives in the economy.

Phil: Absolutely. And headwinds on the other side of the coin, you can see fairly balanced. I think we're more balanced than maybe we were 6 months ago. Softening labor demand. We talked about number of job listings has come down. We are seeing the net gains in payrolls. Still positive, but not quite to the point they were a few quarters ago. So we are seeing a normalizing or softening labor demand.

Waning fiscal stimulus effect. A lot of that fiscal stimulus that boosted us during the pandemic and immediately following has waned, excess savings in consumers' bank accounts, for example.

Residential and commercial real estate. We talked about residential a moment ago. Commercial real estate is something we've talked a ton about, also remains a challenge when you look especially at downtown office space, for example.

Government debt and deficits, something else we discuss quite often that remains a challenge. And then geopolitical tensions, something that essentially always exists but do feel heightened today, are a challenge. And maybe more of a volatility driver than something that, say, puts you into recession, but it can certainly drive volatility within the marketplace.

So speaking of the market, let's turn to the markets. So flipping ahead, what has performed? Total returns by asset class on the left side here. This is year to date, 2024. In terms of equities globally, pretty good performance across the board. US has outperformed. That has been a trend for the last 15 years, let's call it, outperforming both international developed and emerging.

But the truth is we are seeing good performance across global equities. And you're seeing positive performance from fixed income, whether it's the aggregate fixed income or muni-bond. A lot of that has been recently, as yields have come down. Remember, yields down, price up. So year to date, this data's through August 23rd, you are seeing positive returns across the board with the US leading.

Let's look at the breakout of US year-to-date returns within the stock market. So on this grid on the right side, you can see for the whole year to date, growth has outperformed value. Obviously, value is up quite a bit. That wasn't always a story, which you'll talk to in a moment. And large cap has outperformed mid and small. Everything is positive as we sit here through August 23rd. That was not the case in past months when we've shown this.

Brent: Yeah, I like to see that there's a lot more balance.

Phil: That's right.

Brent: It used to be the top right box had all the return and everything else was either very low, zero or negative. We've certainly seen a significant change. And we have talked about in previous webinars that we hope that we see a fundamental rotation. From a health-of-the-markets perspective, we need to see returns outside of the top 10 stocks in the S&P 500. And we started to see that rotation.

If I look at these numbers from the start of the second half of the year, so think July 1st to now. Large value, mid value and small value significantly outperforming large growth, mid growth and small growth. Early stages, right? But not out of the woods. But again, great to see balance and that rotation in the markets from a health perspective.

Phil: Yeah, we'll talk more to that broadening in a moment. But seeing broadening is something we had hoped for. And now we're actually seeing. It is a good sign for the market.

So let's look at the market as a whole. Just a reminder where we have come from. From that October 2022 low, which we had a big sell down in 2022, which you all remember, the S&P is up 57%. And from just last October, up 37%. We had a little mini sell down earlier this month. We're back near all-time highs, clearly a pretty remarkable rally in the market in recent years.

So let's talk more about that broadening that we've seen recently. So as we flip ahead on the left side of this chart, we're looking at the S&P 500 performance year to date, market-cap weighted and equal weighted. Market-cap weighted is the S&P that we all know and see in the news every day. That is where a large company has a much bigger weight than a small company. That is a very top-heavy index. Equal weight means every company, all 500 companies have the same weight, right? So this is a way to show—is everyone participating?

And what you see from this—I said year-to-date, this is Jan 1, 2023, I should say—you can see really incredible top-heavy performance. This is something—the Magnificent Seven, something we've talked about a lot. You hear a lot in the press. To Brent's point earlier, though, on the right side. If you look from July 1st of 2024, the equal weight's outperforming, so it's not just value outperforming growth—it is that you are seeing a broadening outside just those largest companies where the market-cap weighted is still up, but the equal weighted is up even more since July 1st of 2024 of this year. That is something that we take as a real positive. Still early, only a couple months in, but something that I think is a positive for those who want to see the market move higher.

Brent: Absolutely. It's really healthy to see. So let's focus a little bit on the valuation side of the equity markets. And what we're looking at here is the S&P 500's next-12-months P/E ratio. In essence, in English, what is an investor willing to pay for a dollar of the next 12 months' earnings? And what you can see here on the right is that the S&P 500, capitalization-weighted, is relatively expensive. Trading at 21.6 times is in that highest quintile of expensiveness going back to 1985. So the market overall is relatively expensive to history.

But when we go and look at the next slide, Amy, and we look at the bifurcation between the top 10 that you were talking about, sort of that capitalization-weighted structure, which is the gold line here, trading at more than 30 times forward earnings. When I look at the rest of the market—so think the residual 490 stocks—trading at about 17.1 times is more in line with the average. So by and large, the residual 490 stocks are about average as far as pricing on a forward-looking basis, where what's really driving the expensiveness of the S&P 500 in aggregate from a capitalization-weighted basis, as you would expect, is the top 10 stocks.

So when we go forward, let's talk a little bit about corporate earnings and profitability. You know, the one thing that sort of gives me, at least personally, solace in the equity rally that we've seen is that from a fundamental, bottom-up perspective—corporate earnings, profitability, cash flows, revenue growth, earnings growth, net profit margins, gross operating margins—have looked really, really good.

So where are we right now in 2024? The estimated growth for this year is double digits, about 10.1%. That has come down a little bit, Phil. Last time we chatted it was about 10.9%. Again, still incredibly good. Right now we're looking at 2025 estimated earnings growth at about 15.3%. So that's up from 14.8% from the last webinar to 15.3%. Much of that though, Phil, is really base effect that we're seeing from the downward move in 2021.

Phil: Still a good number so far.

Brent: Still a great number. And to your point, Phil, look at the average earnings growth since 1950—at about 7.5%. So significantly better earnings growth this year and expected for next year. I certainly, I think maybe you and I believe that analysts will sharpen their pencil on next year. Time will certainly tell. But robust earnings growth.

On the righthand side, when I think about the next-12-months operating margins for S&P 500 companies, so not now, but expectations over the next 12 months, sitting at a very robust 17.3% is incredibly robust. And when I think about right now, more than 25% of US companies have gross profit margins exceeding 60%, which is just incredible. So overall, the fundamental mosaic and landscape for US corporations remains robust.

Phil: Yeah, there's one chart that one says, why is the market up so much? I'm worried about the election. I'm worried about geopolitical tensions. This is the chart on the right side that I think is the most important chart. It is showing that margins are not only expanding, they're near really artificially high levels post-pandemic. They came down after those artificially high levels where we had huge fiscal monetary stimulus, came down pretty predictably, and now they've recovered. This is what the market trades on, right? And it's something we all need to remember in an election year, that why is the market up so much this year and last year? This is why margins are improving.

So let's talk our price target. Speaking of markets, our base case remains 5,900. We set this last month. Remember this is a next-12-month price target. So we're looking a full year out and that's up about 5% from last Friday. Remember that's up 5% from what is near all-time highs. So we do remain constructive. Our bull case up 15.5%. Our bear case, which would be, you know, pretty severe downturn in the hard-landing-type scenario, down about 22%. So we remain constructive on the marketplace. We did see some volatility earlier this month and have already seen a bounce back from that.

So that's a lot on equities. Let's talk fixed income just for a moment. Here we're showing the yield curve. As a reminder, the vertical Y-axis here is US Treasury yields. The horizontal axis is the date of maturity of those Treasuries. So 1-month all the way out to 30-year.

We're showing a few lines here. We usually only show two. We're making this as complicated as possible for everyone. The year end 2023 is that dark blue line. And then you can see where are we as of August 2023 or 2024 rather, August 23rd, last Friday, very similar. That's the gold line. So the dark blue and the gold line, not much change. If you just didn't check the yield curve all year, not much change, but we have seen incredible intra-year moves. Look at the light-ish, blue-ish line here. That is April 25th of this year. Look how high yields were and how much they have fallen through August of this year. So we've seen a huge downshift, a huge rally, because remember yields down, price up within the Treasury market. So a lot of moves, even though the year-to-date move doesn't look like so much.

Brent: Yeah, and I would say we get a lot of questions from clients related to fixed income and shifting key rate durations, right? A lot of money in cash, Phil, sitting on the sidelines, a lot of money in short duration. And you can see the huge move. And we talked about monetary policy and the expectations for Fed rate cuts. The bond market tends to price much of that in advance. And we've seen such a huge move. You know, we do believe that across the board, as the Fed continues to cut throughout this year and into 2025, as is expected, you might not get as much of a move in the yield curve as people are expecting because we've had so much of a move already. But again, you can see that we've had yields adjust ratably across key rate durations, specifically the belly.

Phil: It's that short end, the front end of the curve that you'd expect to shift as the Fed cuts because a 1-month Treasury is really going to follow the fed funds rate. But further out on the curve, maybe a lot of that's priced in now. We shall see.

So for investors, what does this all mean? Well, the truth is bond yields have moved meaningfully lower. Now you are still getting yield in the marketplace, right? We often have shown this chart and showed yields where they were a couple of years ago. Incredible amount of yields still in the marketplace. But as a reminder that—if you're able to, lock in when you can, right? And don't just sit in money market. There are opportunities within the fixed income, depending on the uses of your money.

But you can see, of course, you know, 1% downward move in the 2-year Treasury. Point-seven percent move in the 10-year. Aggregate bond down 90 basis points. Again, there's still yield here, there's still opportunity, but we have seen a pretty dramatic move down in yields in just a few months.

Brent: Yeah, and I think it's interesting here, specifically if you look at something that a lot of our higher net worth clients are concerned about is, like, municipal bonds in aggregate haven't really seen the move in yields that you would expect from the highs. A lot of that has to do with issuance. We do expect issuance to pick up a little bit as we get into the rest of this year and specifically into 2025 when you go across individual municipalities.

And again, depending on what we see from an election perspective in government, certainly municipal bonds can be a little bit more volatile as we get it through election season and into next year. But again, on an after-tax basis, when you think about highest tax bracket, and specifically if you're subject to looking at AMT or anything along those lines, still a very attractive asset class.

So let's talk about something—like, Phil, I don't know if you've seen, we have an election coming up this November, and we're constantly asked by clients, "Well, geez, how will the election potentially shape equity markets? Should I be concerned about who's in office and what sort of drives returns?"

And by and large, what we're showing here is almost every combination that we've seen over the last, geez, 150 years of partisan control. By and large, you can see that when I sort of look at the middle of the slide and the top are just what the returns were, depending on the composition of government. You can see that the vast majority of occurrences, so sort of look at that second bar from the left all the way through the second to last bar, is that by and large, regardless of the composition and the breakdown of government, the equity markets have returned a pretty decent return.

We're in that very first bar right now with the Democratic president, Democratic Senate, and Republican House. But look at the observations, only 5 years of observations out of this long data sample. Again, historically have seen a very high return. You know, certainly by and large, the equity markets look at the things that we just covered, which is valuations and fundamentals and corporate earnings and profitability. Not so much who is in office or who's running Congress. By and large, the equity markets tend to look through that noise and look more towards the fundamentals of the day.

One of the things that we wanted to show, a couple of new slides here. Phil, you talked about the volatility that we saw in equity markets earlier this year. From July 16th—which was the all-time high in the S&P 500—to August 5th, we saw the equity markets and specifically the S&P 500 fall by a little bit more than 8%.

And a lot of our clients have been asking, "Well, Brent, Phil, what tends to happen after we have a drawdown of that magnitude?" And going back all the way to 1950, you can see after we've had an 8% drawdown and we look at sort of the median return post there, 1, 3, 6, and 12 months, the equity market has posted a positive return. And interestingly enough, Phil, from August 6th through today, the S&P 500 is up more than 8%. So we've started to see history—or so what's happened recently—follow that historical path.

If we wanted to broaden this observation out a little bit more because clients said, "Well, okay, well, let's talk about something maybe a little bit more than 8%. What have we seen?" So what we're looking at here is what's happened after 5% drawdowns, 10% drawdowns and 20% drawdowns. Same time period returns since 1950—what has occurred 6 and 12 months post those drawdowns from a median perspective? And what you can see is if you run your eye down that middle column, when I look at the median return 6 months or 12 months, regardless of drawdown size, it's pretty much been the same return.

But what's interesting is look at the far column when I look at positive occurrences—the bigger the drawdown, the probability of positive occurrences increase significantly. And when we've seen a 20% drawdown, you've seen positive occurrences 76% and 87% of the time on a 6- and 12-month basis.

So I think the name of the game is, at least historically, when we see either a modest drawdown, 10% drawdown, which would be a definition of a correction or something more material, right? Time in the market, not timing the market is what drive returns. And we've seen rebounds in the S&P 500 after sell-offs.

So again, Amy, I see that we have a lot of questions piling up. Why don't we go to Q&A?

Amy: Well, thank you both. And just a reminder to those who may be interested in staying informed throughout the month, we do have several publications that we send out to our subscribers, including a weekly economic outlook from Phil on Monday morning where he shares what you should be looking out for in the week ahead. If you're not already subscribed and are interested in doing so, you can use the QR code or visit FirstCitizens.com/MarketOutlook to get signed up.

So let's jump into questions. Got several this month, probably around some things you may not be too surprised about. But let's jump into this first one. It looks like a foregone conclusion that the Fed will cut rates at their September meeting. So the question is—by how much? If it's going to be 50 basis points or more, is that a sign that the Fed knows something that we don't?

Phil: It's a great question. Yes, it is a foregone conclusion at this point. Chairman Powell made it very clear in Jackson Hole that the Fed would be cutting in September outside of something dramatic changing. The debate is around 25 versus 50. As of this morning, futures are leaning more 25 versus 50, but that could change pretty dramatically.

I tend to think if the Fed cuts 50, it is not an admission they know something we don't. It's an admission that they probably are a little bit late to the game, right? We're seeing a softening, normalizing in the labor market, and it is a way to actually have an impact. A quarter point cut when rates are as high as they are isn't much. Fifty to me would just be a little bit of a "Hey we're going to put a shot in the arm of this cutting cycle" and then they move to quarter point cuts.

More than 50 would take something changing very dramatically between now and September 18th. Imagine a very weak labor market report, inflation coming very low, something geopolitical happening. I think the real debate's between quarter and 50. I don't think a 50 should be concerning. I think it's the Fed admitting that maybe they're, as usual, maybe a little bit late to the game.

Brent: Yeah. And I think, look, you and I would both agree that the policy rate is way too high and restricted. And it's going to certainly take some time. And ultimately, the real question is—what will the ultimate terminal rate be? And I think it's too soon to tell whether the longer-term run rate remains policy-wise at 2% or they use something higher than that. We won't know until we actually get there. But I think we all agree that the rate is way too high relative to the market environment that we see today.

Amy: Brent, this question's for you. The market is sky high. Why would I put my money in the stock market now when we're sure to have a correction in the future?

Brent: Well, I'm glad people know that we're sure to have a correction. They should give us a call and let us know when they know that's going to happen. Look, the one thing that is certain in markets is volatility. I think the other thing that is proven out over the long term is that it is time in the markets, not timing markets that accretes to long-term wealth creation. And again, there's a myriad of things. There's constantly—and you've always said this best, Phil—this wall of worry that we're always climbing. At the end of the day, we think all investors should be centered around either their strategic financial plan, or if you're an institutional client, your investment policy statement. Have a very thoughtful, diversified global multi-asset portfolio that looks forward. Be disciplined in that approach. Do not let the emotions of the day drive how you invest your money. Tying yourself to the mast and sticking to the underlying fundamentals of why you're invested the way that you're invested is what's going to lead to success in our opinion.

So again, I would not worry so much about where the market is today because if I go back through here and just graph the S&P 500, there's lots of high points. And back then, people were saying the exact same thing. This is the all-time market high. The market can't get higher. And every single time it's moved up from there. And you can see that in the graph. So I would say stick to your financial plan, stick to your investment policy statement. And we believe that will serve you well in the long term.

Amy: You both mentioned it's an election year. Unsurprisingly, we got several questions around the presidential nominees and their economic plans and how that may impact markets.

Phil: Yeah, it's a great question. As a reminder, last month we actually had a full election section, and we'll be doing something similar next month, but don't want to beat that horse too dramatically. But in terms of economic plan, honestly, right now there's not all that much clarity on the economic plans of both candidates. Hopefully we have more of that as we move past Labor Day. We know in broad strokes themes, but specifics are what the market cares about.

Additionally, the makeup of Congress is really going to matter. A candidate can say whatever they want to say. If we have a divided executive legislative branch, they aren't going to get it done. Markets, again, it's not fun to say in election years. In election years, we think everything is driven by the election. But just look at the last two presidential cycles. The truth is very different policies and markets performed well in both. Markets turn to fundamentals.

And yes, Washington can impact those fundamentals, but more on the margin than we might want to admit. What really impacts fundamentals is things like cost of goods, global growth, et cetera. And those company margins continue to rise. And that is why the market is up.

Amy: Brent, let's come back to you. What opportunities and pitfalls in general could result from rate cuts and disinflationary measures in the coming days? And how might that impact business owners and the like?

Brent: Yeah, it's a great question. I think broadly the mosaic is that rates are going to be lower in the future through this year, as Phil covered deeply, that the Fed will be cutting rates this year and next. At the end of the day, let's take it in two bites, Amy. Let's talk about the investing side, and then let's talk about the business side.

From an investing side, we've been talking to clients for a long, long time about changing their key rate durations from the attractiveness of money market funds yielding north of 5%. And that being, you know, maybe a short-lived phenomenon as the Fed starts to change their monetary policy approach. We've already seen that. And I think Phil covered that wonderfully when we talked about the Treasury yield curve. We've already seen key rate durations across the entire Treasury curve move materially lower. And when yields fall, bond prices do what? They go up. So at the end of the day, we've already started to see bonds across various key rate duration, specifically think that 2-, 3-year, all the way out to that belly, 10-years and beyond, start to come down, and that bond prices go up. We think that will continue.

So we do believe it's not too late to think about extending duration where it's appropriate for either your personal financial goals and objectives or your investment policy statement. But where you have the opportunity to extend maturities beyond cash and short-term out throughout the belly and longer, we think that that makes sense.

So that's the investment side of things. From a business side, think about the small and medium-sized businesses that we get to see when we travel around the country. They are rate-sensitive. So we think a lower rate environment should bode well, hopefully for small-to-medium-sized business confidence and maybe help quell some of that uncertainty as we get to more certainty as it relates to rates and where the Fed is.

Phil: For those rate-sensitive parts of the economy—think small-cap stocks, think private, small-cap companies—rates coming in could certainly be a real positive from a borrowing perspective.

Brent: Absolutely.

Amy: So with ongoing tensions in the Middle East there's a lot of concern around prices in oil and the future of that industry—you want to talk a little bit about that?

Phil: Sure. So it's pretty incredible. I just pulled up oil on my screen, seeing this question. WTI, this morning's trading straight at $75. I looked at this yesterday. That's something like 8%—or as of yesterday was 8%—below where it was a year ago. Think about all the tensions that have happened in the Middle East over the last year and oil is down.

So certainly if there's risk to the up or downside there, you would think to the upside. But it is really a reminder that it's very difficult to predict the price of commodities. Because if you told me everything that happened in the Middle East over the last year, I'd say, well, oil is higher. It's 8% lower. It's dramatically lower. That is a risk, but right now it is not. Right now it's completely contained and that's what feeds into what we pay at the pump.

Brent: Yeah, absolutely. I mean, $75-a-barrel oil is not an economic headwind for consumers, right? So again, anything can happen, right? And we've seen a lot of volatility, but by and large, oil hasn't been that restrictive force within our economy.

Phil: That's right. And it's really absorbed some pretty serious headlines in the Middle East. It's absorbed those pretty well.

Amy: Well, thank you both as always. Thank you for the new slides. It's always a fun thing to get to see. Thank you for taking a deep dive into both the bond markets and the equity market. Lots to consider as we move into the early fall, hopefully in some lower temperatures and football season as well.

We hope you found this information helpful, and we will be back with you next month. As always, thank you for allowing us to bring this information to you. That is something that we never take for granted. Thank you, guys.

Phil: Thank you.

Authors

Brent Ciliano CFA | SVP, Chief Investment Officer

Capital Management Group | First Citizens Bank

8510 Colonnade Center Drive | Raleigh, NC 27615

Brent.Ciliano@FirstCitizens.com | 919-716-2650

Phillip Neuhart | SVP, Director of Market & Economic Research

Capital Management Group | First Citizens Bank

8510 Colonnade Center Drive | Raleigh, NC 27615

Phillip.Neuhart@FirstCitizens.com | 919-716-2403

Blake Taylor | VP, Market & Economic Research Analyst

Capital Management Group | First Citizens Bank

8510 Colonnade Center Drive | Raleigh, NC 27615

Blake.Taylor@FirstCitizens.com | 919-716-7964

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