Making Sense: January 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, our Director of Market and Economic Research. Today is Tuesday, January 23rd, 2024, and I want to welcome you to our monthly Making Sense: Market Update series.

This is our first discussion in 2024, and we will be seeing you every month throughout the year. 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. If you have any questions or concerns about your financial plan, please reach out to your First Citizens partner.

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

Brent: Great. Thanks, Amy. Good afternoon, everyone. Hope all of you are well. Well, Phil, 2023 is officially in the record books, and what a crazy year it was—and we're on to 2024.

Phil: Yeah, really something else. Rate volatility, geopolitical risk, concerns around inflation and recession for most of the year that really have started to wane now, which is good to see—but really quite a year for markets.

Brent: Absolutely. So let's jump in, and what are we going to talk about today? So Phil and I are going to give you an economic update. We're going to cover growth, both here and abroad. We'll talk about inflation. We'll talk about interest rates, monetary policy, the labor market, the consumer—a lot to talk about there. And then given that it's January, we'll give a market update, but we're going to wrap up 2023 and talk about what happened in equity markets, what happened in fixed income markets in 2023.

And because it's January, we'll talk about maybe where we're going to go in 2024, even though it's a little bit early. We'll cover our price target and lots of other things.

So, Amy, let's jump right in and let's get into the economic update, and let's start on the growth side. So expectations coming into 2023, Phil, were that significant monetary policy actions both here and abroad would curtail growth, and you can see that analysts predicted that we were going to materially slow from the 1.9% that we saw at the end of 2022, all the way down to 0.4% last year. You know, slowing policy actions broadly would slow growth. And by and large, the good news is the US economy was significantly more resilient—strong consumer, strong spending, services economy. And not only did we not see a contraction from 1.9% to 0.4%, as of right now, expectations are that we grew 2.4% in fiscal 2023, which would be actually an expansion of almost about 50 basis points.

Phil: And you really see that outside the US as well, Brent. Look at that December 22 column versus where we are today. Outside the US, really global growth surprised the upside as well. Makes some sense that markets performed well from a risk market perspective.

Brent: Absolutely. So here we find ourselves again in that same position, that same narrative where significant monetary policy actions and the long and variable lags associated to those actions will slow growth here in 2024. And you can see consensus expectations believe that we're going to fall from 2.4% in 2023 down to 1.3% this year, which would be a material contraction. And again, time will certainly tell and will be data dependent.

Broadly though, on the next slide, Amy, the US economy is, in fact, slowing—and the pace of economic activity is moderating. What we're looking at here is the gold line is manufacturing, gray line is services, and you can see both have moderated significantly lower from the multi-decade highs that we saw back in 2021.

Let's focus first on manufacturing, which is the gold line there. Not only is manufacturing moderated lower, Phil, but we've dropped below that line that divides expansion from contraction. And you can see we've basically bumped along sideways as it relates to a broad manufacturing activity, re-accelerating. And we saw in December move up from the 46.6 that we have up to 47.4. So been bumping along, but manufacturing maybe at the margin is starting to pick up a little bit. I think time will tell whether or not we truly see that escape velocity.

On the services side, we've seen significant moderation from the August 2023, and we've seen services fall all the way down to 50.6. So by and large, whether it's manufacturing or services, we're starting to see some moderating of economic activity.

One of the reasons has been, as we just mentioned, monetary policy. What we're looking at here is every hiking cycle post 1982, the gold line is this cycle and you can see as it relates to basis points of hikes within a compressed period of time—this has been the most significant policy in more than 40-plus years. So we've been on hold since the July meeting last year, and expectations for this year are pretty significant.

Phil: Yeah. So if you look at first, "What is the Fed saying in their own summary of economic projections from December?" They're indicating something like three cuts this year. The market disagrees. As of this moment, there is a 42% chance that the first cut is in March. As of a few weeks ago, that was 75, 80% chance of the first cut being in March. So the truth is markets are backing away from the idea the Fed's cutting very soon.

We have been in the camp that March sounded pretty early to us, more like mid-year would be the first cut. Currently, futures are pricing five to six cuts. That was six to seven cuts as of a few weeks ago. Again, we're skeptical that we get to six or seven cuts. It could happen, but if it does, it probably means something broke in the economy, so be careful what you wish for from a market perspective. But certainly likely the Fed is cutting this year. The question is, when do they start? But in our view, more like mid-year.

We will learn a lot next week at the next Fed meeting. That press conference from Chairman Powell will be watched very closely. In terms of what indication for the March meeting does he give. The market could really swing one way or another, depending if he sounds dovish or hawkish.

Looking at the Fed data a little deeper here on the next slide. Here we're showing the Fed funds rate. That's just the overnight rate we're all familiar with. And then something called the proxy effective funds rate. This is a calculation that the Fed actually provides, takes into account their balance sheet and other factors to say, really, "What is policy beyond just the Fed funds rate?" And one thing you'll notice that I think is really interesting is before say, 2016, all the way back to 2010—sort of the period after the Great Financial Crisis—look at where the proxy effective funds rate was relative to the normal Federal funds rate. It was negative. So unbelievably accommodative policy, really easy monetary policy. You saw it turn negative again right after the pandemic, but nothing compared to where we were after the Great Financial Crisis.

But as the Fed is hiked, and they are going from an era of quantitative easing to quantitative tightening, you now see that the proxy rate is above the Fed funds rate. In other words, conditions are even tighter than the Fed funds rate would tell you. And it's come down. Why is that? Rates have fallen since last October. But it does indicate that the Fed does potentially have some room to cut this year just looking at that spread from their proxy rate to the normal Fed funds rate. So why has the Fed been so aggressive, and what is the debate? Well, it's about inflation as we flip ahead.

The consumer price index, as we've mentioned many times, peaked at 9.1% in the summer of 2022. It has fallen. It currently sits at 3.4%. That's the gold line here. The gray line is core. This excludes food and energy. That's at 3.9% above headline. So what you'll notice on that gold line—the headline inflation rate—it fell precipitously. And now we're kind of in a channel. So when you're thinking, "Why has the market backed away from the idea of the Fed funds rate—or the Fed cutting the Fed funds rate in March?" Well, this is one of the reasons is we just got some fresh data, and it surprised the upside. The truth is we need to get down to 2%. That's the Fed's target. We've improved. We've come a long ways, but we need to see further improvement. So could we see further improvement?

As we flip ahead, one major driver of inflation—in fact 25% of the consumer price index—is owners' equivalent rent. Now, that is a measure in which the BLS, the Bureau of Labor Statistics, is attempting to calculate what does it cost to own a home. It's a controversial, somewhat flawed measure.

Brent: My least favorite measure.

Phil: Yeah, it's basically a survey. But what you can do is compare it to more market-based measures like the Zillow Rent Index. And on a 9-month—if you leave the Zillow Rent Index 9 months, in other words lag owners' equivalent rent—it does tend to follow. We've showed this for months.

In fact, I think when we started showing this, we hadn't even quite hit the peak, but we were saying, "Look, at some point you'd expect it to follow." Well, that's finally started. You're starting to see it. If this trend continues, that's really good news for CPI. Again, 25% of the CPI is this one kind of unique measure of the cost of housing.

So what's consensus believe, as we turn ahead? The gold bars here. These are just economic consensus expectations of Consumer Price Index year on year. As you look, end of this year—2.4%. Fourth quarter going into the middle of next year—2.3%. If this were to happen and we're getting mid-twos by the middle of this year and even lower as we move later in the year, then the Fed probably has the green light to cut, right? Because the real rate would be quite positive at that point. So it's not "Is the Fed going to start cutting?" It's more about when and how much—and that is what the market's moving on. Look at the move in rates fourth quarter of last year versus what we've seen this year as the market changes its mind pretty continually on what the Fed is going to do.

Brent: So, you know, aside from inflation, and, you know, I agree that the data is likely to improve on not getting ultimately to that target. But one of the pillars of strength continues to be the labor market where in this cycle we've added hundreds of thousands of jobs, Phil. And to update everybody on where we stand right now with the December data. Consensus expectations were calling for 175,000 jobs created. We came in above that—exceeded consensus at 216,000 jobs created. So that was a nice beat.

We did have a little bit of a revision for the November data where we had revised the data down from 199,000 jobs down to about 173,000 jobs. So a little bit of a revision there, but that was kind of expected. The U3 unemployment rate, which we'll get into a little bit more, is sitting around 3.7%. So only about 0.3% away from the lowest reading that we've had in more than 60 years, which was 3.4% back in April of last year. So, again, the labor market continues to be that pillar of strength.

And as you'll get into a little bit when we talk about consumption and consumer spending broadly—incredibly important to make sure that gainful employment leads to spending.

Phil: If there is one thing that surprised the experts last year, it's the labor market. I mean, consensus expected odds on we were going to have a recession at some point last year. Well, the labor market has remained resilient. 70% of consumptions—consumer spending. So if the labor market people have jobs, they're going to tend to spend it up.

Brent: So looking at that U3 unemployment rate a little bit more deeply—you can see the unemployment rate all the way back in time to the 60s. And you can see, on average, unemployment rate has been 5.7%. And you can see we're rarely actually on that average. It's either coming through or coming down. But by and large, putting it into perspective, sitting at 3.7%—a full two percentage points below average inflation—gives you a little bit of an understanding of how tight the labor market still is. And when we look at jobless claims and continuing claims, still historically low, right? You know, time will tell.

And we'll talk a little bit later as it relates to corporate earnings and profitability and operating margins, and obviously payrolls, headcount are a material input to P&L expense for companies. And will we see that unemployment rate start to tick up as companies look to improve margins and earnings? Time will tell. But for right now, the unemployment rate remains historically low, and the labor market remains fundamentally robust.

Phil: Yeah, and that robust labor market, as we flip ahead, a tight labor market has continued to drive wage gains. This is US average hourly earnings just year-on-year percent change—currently at 4.1%. It has fallen from its high, but is still elevated.

So think about CPI I said was 3.4%—this is 4.1%. So unlike when CPI was extremely high, you now have wagers on average earning above the rate of inflation.

Brent: Yeah, real wage growth.

Phil: So that's really good news for consumer. The other side of that coin, though, is the Fed. So the Fed does have to watch wage inflation, not just price inflation—because wage inflation could find its way into the economy. We all remember the term wage price spiral from the 1970s.

So the truth is, when you think about, you know, "Is the Fed height cutting, say, in March?" Another reason those odds started to fall is because this report came out, and you see that uptick in wage inflation. This was a surprise to the upside. So this is a double-edged sword. It's good for consumer. You want wage inflation. You don't want a wageless recovery like you had after the financial crisis. We also don't want wage inflation so high that it drives the Fed to keep monetary policy too tight. So we want this and price inflation to continue to fall.

But that wage inflation, as we flip ahead, has driven personal consumption. So personal consumption—fancy word for people going out and spending money, right? Now, they are spending more on services—that's the gray line here that's above the 20-year average, as you can see—than they are on goods, which is still growing, but below the 20-year average. We had this explosion in goods spending during the pandemic. We're all stuck at home.

Now people are spending on services. If you spend a lot of time in airports, you're witnessing this. If you go to restaurants, you're witnessing this. The truth is that the consumer is doing well and that has kept us afloat. Now, something we've shown in for maybe the last 8 months or more was a T-chart showing what could put us into recession, what could keep us out of recession. We're going to stop showing that, and the reason is—the truth is it would seem that the economy is in something somewhat sustainable here.

So we had a recession probability of 60%. We are removing that. The highest we ever got was 60%. And now if we need to revisit, we will. But we're not going to update that, you know, month to month. We will come to you if it seems like the underlying activity is starting to weaken again, and we'll discuss that with you all. But for now, it does appear that the economy is in some sort of expansion trend.

Brent: Absolutely. So why don't we shift gears, Amy, and let's talk about market update. And let's start, Phil, first with a recap of the incredible year that was 2023. You can see on the left-hand side of this slide, we're showing you the returns for US equities, international equities, emerging markets, as well as both taxable and municipal bonds.

So kind of stepping away from the slide just for a second, encapsulating all of last year. It overall was a great year—25.9% return for US stocks. You know, 5-plus percent return for both taxable bonds and municipal bonds. If you never looked under the hood and just saw that full year, you're like, "Wow, it was a great year for balanced portfolios." But how we got there was incredibly interesting.

From January 1st all the way through to Halloween, Phil, the US equity market is represented by the Russell 3000, which is all stocks, both large, mid and small—was only up 9.4%. Taxable bonds and municipal bonds were negative 2-and-change percent through Halloween. The last 2 months of the year, November and December, drove almost all the returns for both equity markets—and most specifically for fixed-income markets—which kept us away from 3 consecutive years in a row of negative fixed-income markets.

We saw over 15% return in US equity markets in November and December, more than 8% returns for taxable bonds and municipal bonds that allow us to get to that point. So at the last 2 months of the year, we pulled forward, I think, a lot of returns that we might have been expecting in 2024, into the last 2 months of the year, which will be interesting for the trajectory of markets forward from here, which I know that we'll get into in just a second. When you look at the right-hand side of the graph inside of US equities, where did things work and where might they didn't work as well?

What you can see is, again, large-cap growth, the Magnificent Seven, the top ten stocks within the S&P 500 really drove the returns in US equity markets. And what I think is really interesting is look at the gapping between US large-cap growth stocks and US large-cap value stocks—30% difference in a calendar year between large value and large growth. So just an incredible spread.

So it's not only did you own US equities in fiscal 2023—what specifically did you own within US equities that really drove markets broadly. So when you flip to the next slide, Amy, looking at the chart on the right here, you can see that finally, after 2 years of not seeing a high in the S&P 500, we finally broke through that in early January here. It took 506 trading days, Phil, to get there, so more than two years. We finally passed through the high that we had back on January 4th of 2022, and now eclipsed that.

But I think what's really interesting, Phil, as you can see, we hit the low in the S&P 500 on October 12th of 2022—basically 3,577—and we've run more than 30% from there. Interestingly, along the way, while we thought there was a good bit of volatility, or at least it felt that way—we saw only two drawdowns last year, negative 8%, negative 10%. We've covered this before. On average, we're looking at a negative 15% intra-year drawdown. So while we did see some volatility last year—by and large, not nearly as volatile as we've seen in average years.

Phil: It was one of those situations where it felt like the news headlines were maybe a little bit more volatile than the way the market behaved. This really does surprise our clients when we're on the road.

Brent: And interestingly, on the chart on the right, when you look at the cap-weighted S&P 500, which was driven by that Magnificent Seven up 26.3%, the equal-weighted didn't do as well as the cap-weighted, but was still decent at almost 14%.

And what's really, really interesting is that if you were to bifurcate the year from June 30th of 2023 to the end of the year, the equal-weighted S&P 500 and the cap-weighted S&P 500 had almost identical returns. It was really the first 6 months of last year that really blew out the gapping between like the Magnificent Seven and the average stock within the S&P 500. Year to date, it's basically been kind of flattish between cap-weighted and equal-weighted. And time will tell whether or not we start to migrate away and see more balance in equity returns within the S&P 500.

Phil: Yeah, it's going to remain a major topic this year. Does return continue to broaden out? Does it hit mid-cap, small-cap value? We'd love to see that because that be a great sign for the market, but it's certainly too early to tell.

So let's turn to some of the fundamentals that drive markets. Earnings 2023, we're in the middle of fourth quarter earnings. So far companies are beating, but they're beating admittedly a lowered bar, certainly. There's still a lot of earnings to come, so we shall see. But right now, the estimate's roughly 0.5% earnings growth in 2023.

So again, markets sold off in 2022. It was looking ahead to some sort of—maybe not earnings recession—but certainly some sort of muted earnings in 2023. Well, in 2023, market goes up very rapidly, looking ahead to potentially really good earnings in 2024. Consensus at 11.8%. That seems a bit rich to us, but we do think we see earnings growth this year.

Something that does really please us, I think it's one of the reasons the market rallied so hard last year, including the fourth quarter, is that you have seen an improvement in expected operating margins. If there is one thing that markets care about—we spend a lot of time talking about elections—it's operating margins, right? If operating margin's swinging up, markets tend to perform pretty well, and you can see there that we had some deterioration in operating margin really from unsustainable highs after the easy money policies of the pandemic to 2023 sort of a bottoming—and really expansion now for months. I think that this is a real driver of markets.

Brent: Yeah. And I think it's going to be interesting to see that whether or not—kind of tying it back to when we were talking about unemployment—you know, what will S&P 500 companies do to continue to improve those operating margins and hit these lofty earnings? You know, will that result in potential headcounts?

We started to see that a little bit in technology. We've seen that in financials, so time will tell how companies get to those ultimate earnings. You know, hopefully it's a good bit of revenue growth and expansion and less so on expense-cutting to actually get to those better margins.

Phil: Absolutely. So let's talk about the market multiple. We talked about earnings. So what is the price an investor is willing to pay for a dollar of earnings? This is for 12-month price-to-earnings ratio. Many of you are familiar with this. Here we are showing the price-to-earnings ratio in gold. And we have an average and one standard deviation up and down.

What you'll notice is the market certainly is—around 20 times—certainly is not cheap. It's above the one standard deviation line. But what you will also notice is the market rarely trades at that average. So one of the things that bothers us the most if we're watching financial news media is the market's cheap or expensive versus average. Well, that doesn't tell you very much about where the market's going tomorrow. It may tell you in the long term, but in the near term, it does not tell you very much.

In fact, the markets stay cheap or expensive for many years, as you can see here. But if you are thinking about positives and negatives, there's a lot of positives for the market. Valuation is not one of them, right? It is not a cheap market. Again, that does not mean the market's selling off tomorrow, but certainly you are not buying a cheap market at these levels.

So what is our price target as we move ahead? Our base case is 4,850. When we set this number in December, it was up single digits, mid-single digits. And what happened? Well, the market rallied 4.4% in December. As a reminder, the S&P rallied 8.9% in November. So 4.4% December, 8.9% annualized. Yeah, annualize those numbers in your mind. You mentioned a pull forward. There's a chance we had a bit of a pull forward late last year.

Now there is also a chance that the bull case is more going to play out. There's a reason we have a bear and a bull case. Bull case is a scenario where you don't have dramatic earnings revisions. In fact, earnings revisions may be up. You have above-average earnings growth in the out year, sort of year two. And you might have multiple expansion, which we have seen multiple expansions as we set the price target.

So there is a framework here that potentially we do move higher. That said—and Brent's going to outline it—there are reasons to think we could have some volatility this year, and thinking we're just going to move up in a straight line is probably unwise.

Brent: Yeah. And when you look at this here—at our base case at 4,850. If we just look at Wall Street top-down consensus, right, you've seen one of the widest gappings between expected base cases that we've seen in years. The low is 4,200. The high is 5,200. There's a thousand points between base cases for firms. Mean and median, ironically, is right on our base case right here. And obviously, we put out ours before they did. So ultimately, again, wide views out there as to where the equity markets go this year.

Again, we do believe that we're going to see maybe more muted returns this year. But again, we did pull forward a significant amount of returns in the last 2 months of the year. But again, somewhere maybe between base and bull is somewhere where we could find ourselves.

Phil: Yeah, absolutely.

Brent: So a question, Phil, that we're going to be getting an awful lot—and I'm gearing up for an election year and the political discussions that we have. Again this year is an election year. What we're showing you here is, number one, gold line is all years for the S&P 500 post-1952. So basically post-World War II. The gray line are presidential election years. And what you can see is—historically, right—that January and February tends to be volatile, right? You know, a little bit of downward movement. So it would not be out of the realm of feasibility that we see the market maybe sell off a little bit here at the end of January into February. That would actually follow in line with historical data.

But once you kind of get past that—let's say towards the end of the first quarter, all the way through the end of the summer—you again, similar to all years, you see a pretty significant move up, not in a straight line. It is lumpy, but you tend to see markets move up. But then once you kind of get in election years post-summertime—as you kind of get into that September and October, November, when elections start to heat up— you tend to see a little bit more volatility and a little bit of a downward slide, a little bit more than what you would see in normal non-presidential election years or all years together.

But kind of, again, that seasonal effect in that November, December, again, you can see that gray line moving up. Broadly, we do see positive years—at least historically, small sample in election years. I think we covered this in a previous WebEx. When you look at election years, when you have a newly elected president, which we have, and Joe Biden was a newly elected president, on average, the markets have been positive 100% of observations with an average return of 11.8%. So again, small data set, but by and large, tend to be positive in election years.

So let's shift gears away from equities, Phil, and let's talk about fixed income. What we're looking at here is US government bonds and the US Treasury yield curve. The gold line is where we were at the end of last year. The gray line is effectively where we started the year. And it looks more like a piece of abstract modern art than it does a yield curve.

Phil: It's messy.

Brent: But if you told me that we would basically start and end the year on the 10-Year Treasury at exactly the same level, given what was going on in monetary policy and the incredible volatility that we saw in rates, I would think you're crazy. But that's exactly where we ended up.

Phil: And as a reminder, the 10-Year was touching 5% in October.

Brent: That's right, that's right.

Phil: So we had a major move down, but somehow the round trip is the 10-Year was relatively unchanged. That part of the curve is relatively unchanged in the year. Now for fixed-income investors and traders, this of course was an incredible ride of a year, but relatively unchanged. You'll notice that the short end of the curve, of course, is much higher. Why is that? The Fed was hiking and the short end of the curve is all about Fed policy.

Brent: But it is interesting to your point when you look at the belly kind of in—kind of seven and in—you know, that was a much, much different picture, you know, in September, October and June. But we've seen the belly-in of the curve come down materially—again, expectations as to what the Fed might do this year as it relates to rate policy.

So moving forward beyond treasuries, let's talk about credit spreads and credit markets. And remember, a credit spread is nothing more than the premium that you put on top of a default, risk-free asset—i.e. the treasury—to own the risk inherent in a corporate bond.

Phil: So if this number is high, there's more risk in the marketplace. If this number is low, there's less risk.

Brent: Yeah. So what is interesting is credit spreads right now have been relatively sanguine. I mean, look at where we had the volatility back in October of 2022, where you had the equity market volatility. Spreads only widened out to about 194 basis points—compared to where we were back in the pandemic, where we had 350-plus. So by and large, risk within credit markets have been, at least in investment grade credit markets, relatively sanguine, and we remain that way. We've had incredible issuance so far in 2024. We're likely to see more corporate bond issuance this year. By and large, the spreads relative to treasuries continue to remain relatively benign.

Phil: Right. And so we mentioned rates fell late in the year—it's one of the reasons stocks rallied. But rates still remain and yields still remain attractive as we flip ahead, Amy. So if you look at, where were we beginning of 2022—not that long ago—versus where did end 2023? Look at the 2-Year—0.73% versus 4.25%. 10-Year—1.5% versus 3.9%. By the way, these rates have risen this year. The 10-Year's north of 4%, around 4.12%, so even more attractive.

But from an investor perspective, this is still the paradigm shift. The truth is, yes, the stock market's been volatile. That's what the stock market does, right? What has changed is that we went from incredibly low yields—that we had trended lower for decades—and now we've normalized. And suddenly, fixed income is a more attractive asset class. When you think about the balance between stock and bond portfolios, all of a sudden, that bond portion has some expected return through yield.

Brent: Yeah, and we covered this in the 2024 Outlook when we talk about the Horizon Actuarial Study, which looked at 42 firms and their views of what stock market returns or other asset class returns are going to be over the next 10 years. The consensus was about 7% for US equities over the next decade. Well, right now, adjusting this on the fly, Agg bonds about 4.6%.

You adjust municipals for either 35% or 37% tax bracket, and on your Medicare surcharge, you're at 5.25. So the spread between stock-expected returns and where yield-to-worse are right now for fixed income is way more balanced than it was back at the decade that ended 12/31 of 2021—so again, investors can have a more diversified, balanced portfolio and be able to sleep better at night as it relates to having stock and bond diversification.

Phil: That's right. So speaking of investors, let's talk investor behavior. A question we get maybe more than any other question is, "When should I put money in the market? When should I take it out?" And unfortunately, it's a boring answer. But the answer—the shorthand is—don't try to time markets, right? Academic research shows that, but also simple research like what we're showing here shows it as well. Staying invested is what pays. Now, remember, this is always in the context of your financial plan—or if you're an institution, the goals of various asset pools.

Equities are long-term assets, right? They are not short-term assets. There's going to be volatility. The last 2 years have reminded us, but what do you see as you look at attempts at market timing in the past? So here we're looking from 1992 through 2021. If you put $10,000 in 1992, at the end of 2021, that was $208,000—which first of all, that's amazing.

Brent: Twenty-one times your money's pretty good.

Phil: That's reminding, reinvesting dividends, all this matters. If you—so that's thousands of trading days, right? Decades of trading days. If you missed only the 10 best trading days, your return falls 54% to 95,000. If you miss 20, your return falls 73% to 56,000. Why might that be? Well, the answer is there are some really big moves day to day in the market—particularly within bear markets.

So nearly half of the index's strongest days occur during a bear market. Think about 2020. Take your mind back there. Do you remember days in which the market was up high single digits in a day, down high single digits in a day?

That one day could be a year, year-and-a-half overturned, so that is why this matters. Another 28% of the market's best days took place in the first 2 months of a bull market when people don't know. One of the issues with trying to market time—it's not just getting the sell right. When you buy, right? So you sold at the peak in 2020. Did you buy in 2020? That remains the question. So 75% of best days occur during a bear market or soon thereafter. Just to beat this dead horse, let's look at this a different way.

Brent: I like this one.

Phil: Yeah. This is some analysis we did last year. Imagine you're an investor. You have $12,000 to invest each year, 1980 through 2023. And we have four scenarios here. The first scenario is perfect timing. Each year, you invest that $12, 000 at the yearly low for the S&P 500. So that might be March 2nd one year. That might be November 3rd another year. This is impossible, but somehow you're omnipotent, and you invest at the yearly low each year. First of all, that becomes $10.5 million. That's incredible. But also that means you captured 100% of that perfect timing.

So the other scenarios, worst timing means—this is Murphy's Law. Somehow each year you buy at the yearly high. One year that's June 2nd. The next year that's December 15th. But somehow you have the worst timing of anyone on the planet. Again, this is not possible.

Brent: Yeah, for 40 years in a row.

Phil: For 40 years in a row, you have the worst timing. You still somehow capture 76% of that perfect timing—76% of that $10.5 million. So now let's take two more real-world scenarios. First day of the year, you put $12,000 in, right? People do this. You put money into the market first day of the year. In that scenario, you capture 92% of that $10.5 million—a rounding error away. And then another really common scenario, monthly dollar cost average. You were able to put $1,000 into the market each month. That's through 401k or whatever it might be. You capture 87% of that $10.5 million.

So the short answer is—don't try to time markets. Really, no matter the scenario, you are winning. Now look at cash. That's the gray bar. If you were just in cash, you're sitting in cash—you're waiting, you're waiting, you're waiting, you wait for decades. In each scenario, you only capture 5% of the return of the stock market. Why is that? Because cash return is lower over long periods of time than stock, so for long-term investors—staying invested is the winning tactic.

Brent: Absolutely, and I think again with everything going on, unfortunately, in Ukraine right and Gaza, and we have an election coming up—there is always, Phil, this incredible wall of worry that prevents investors from doing what you just said.

But what you can see is if I put $10,000 into the market on 12/31 of 1969—basically from 1970 all the way through today—you annualize to 10.6% per year. Look at all the things that would have distracted you from being invested. There's always something. But again, if you have a financial plan, if you have a disciplined investment approach and you stay invested and you stop worrying about market timing—when to get out, when to get in—because there doesn't exist a firm or a person that can consistently time when to get out and then, conversely, back in. Again, staying invested has accreted wealth over the long term. And it's something that we think that all investors should be mindful of.

So, Amy, I know that we have a lot of questions. Why don't we pivot from here and get into that?

Amy: Thank you, Brent. Thank you, Phil. Before we jump into questions, just a reminder that we do have publications throughout the month, including weekly In Brief. That gives you a look at the week ahead every single Monday morning. We also have a Q&A Series where we answer some of the questions we're hearing most often from clients.

If you'd like to hear a question or submit a question for a future publication, be sure to go to firstcitizens.com/wealth and get your questions submitted. You can also subscribe to our email system and get all of this stuff sent directly into your inbox throughout the month.

Brent, let's jump into questions. And we do have quite a few on what we were just talking about. The market is at an all-time high. Should we be afraid? Are the wheels sturdy enough to keep this train moving?

Brent: Yes. So aside from the slides that we just showed that you should always remain invested and stay invested because it creates long-term wealth. Yeah, it's been interesting, right? So post-World War II, we've had about eight times where it took more than 2 years to go from a previous high to a new high. Thank you, Amy.

And again, this time around, it took 506 trading days to get back to the high that we saw back on January 4th of 2022. So historically—I know, small sample size still—what happened 12 months post-hitting that high or new high, what happened 12 months post? Well, 100% of those eight observations—one year later, the equity markets were positive. The average return post that high has been 11.3%.

So again, from an historical perspective, again, small sample size, once we hit a new high—and it's taken a little while to get to that new high—the equity market has been positive 12 months later, varied in degree, but on average about 11.3%. So again, have a financial plan, stick with that plan. Be balanced between stocks and bonds based on your risk tolerance or your investment policy statement if you're an institutional investor. But again, please don't time the market. Stay fundamentally invested.

Amy: Phil, we talked about the mixed jobs report and the inflation data that just came in in December. Was any of that impactful enough to change the Fed's monetary trajectory?

Phil: Well, the market thinks so. We've watched interest rates rise. We've watched probability of rate cuts in March fall—and for the full year fall as well. So look, the Fed—it's boring. They are somewhat data dependent. Now, they're dependent on a lot of things, but data is part of it.

When you have wage inflation surprise the upside, you have CPI more elevated than they want—and certainly surprising—those are drivers. Now there's other good data. PPI, Producer Price Index, came in lower, so it is a balance. But certainly if you watch markets—some of that's being priced.

Now we were kind of already there. We thought the market was way ahead of itself in terms of expecting a cut in March, and the market's moving our direction there. But, yes, from the employment report standpoint—as long as there's job gains, the market's happy.

The wage line is quickly becoming the most important part of it. What does wage inflation look like? And then when you're watching CPI and Personal Consumption Expenditure Deflator—look at the core, right? Exclude food and energy. As gas prices go up, they go down. What is underlying inflation? And the truth is, in CPI, core inflation is still above headline inflation. So, yes, the answer is—the Fed is absolutely watching this data. And some of the data that was released in January was a little hotter than they might have liked. And we are seeing bond markets and futures markets move on that.

Brent: Yeah, I think that's a really good point. I think from a financial markets perspective—you're likely to see continued volatility. So I don't think it's a straight shot down for yields across either the Treasury curve or other asset classes within fixed income. I think you're going to have a good bit of moderation and volatility along the way till we actually get to that trajectory. But once we actually kind of get that first cut behind us—we'll have to just sort of wait and see—but usually when you take a longer term for you, let's say 3 years from that first cut, more often than not, that tends to bode well for financial assets specifically.

Phil: And that's why, you know, 2 pm on January 31st—the next Fed statement release and the following press conference—is going to be really important for markets because the Fed, if they are going to cut in March, are going to need to start to signal that to the marketplace. So that press conference is going to be a really important one. They're always important. This one feels pretty critical considering this is the first time the market has believed there was a cut imminently, potentially.

Amy: Brent, I know this is your favorite topic, and we got a lot of questions on it, but I can boil it down to just a couple here. How far out from election day could we start to see the impact in markets, either positive or negative? And also, is the market already pricing in one party over another?

Brent: Good question. If I take a 100,000-foot view, and I go back and I look at 150-plus years of election data, party data and equity markets—at the end of the day, and this might bother some folks—it really doesn't matter, from a market perspective, who's in office.

I think if I go back and look at long-term returns and looking at Democrats in the presidency versus Republican, I think it's like 11% and 9-and-change percent. So at the end of the day, regardless of what party is in office, it's a rounding error between what equity markets have done.

But yes, thank you, Amy. In election years, if we talk about more tactically what could happen this year if this year follows along with the historical norms. We, again, might see some volatility here in the first 2 months of the year. Tends to be kind of a, you know, smooth shot up—some volatility along the way. But when you kind of get to the summer and people start to have the election on their minds, you start to see a little bit of volatility. But then, you know, the seasonality kicks in in that fourth quarter—specifically November, December tends to be shot up.

Overall, election years tend to be a little bit lower return than all years combined. But by and large, you shouldn't allow the elections to drive your investment decisions.

Phil: Right. And, you know, something to remember is—the market's going to return to fundamentals. So when you think about what is in these election years—first of all, it's every four years, so it's smaller sample size. 2008 was an election year. That was the Great Financial Crisis. That did not have too much to do with the election. 2000 was an election year. That's the end of the tech bubble. That did not have too much to do with the fact that it was an election year. So there's drivers that are fundamental that we need to focus on more than the fact that we have an election—and this period is just so unique.

We had a pandemic. We had a global economy that was shut down, reopened, explosive inflation, high interest rates. That's what the market's going to come back to very quickly. Do elections matter for certain sectors? Yes. But very quickly, the market's going to say, "What are the net margins of the S&P 500? What do earnings look like? And what's the multiple I want to pay on those earnings?"

Brent: Absolutely.

Amy: Hey, Phil, can you give us an update on the commercial real estate market? Are there still concerns for broad failures with so many people going back into the workplace?

Phil: Yeah, absolutely. So commercial real estate remains a hot topic. In fact, in our Ten Things To Watch outlook from December, commercial real estate was one of our topics—still a major topic. If you look broadly across commercial real estate, year-on-year price declines persist. Office has seen the biggest declines, but it's outside of just office.

And look, it's very regional. It can be different in terms of metro office versus suburban office in a metro area. But it still is a concern—$1.5 trillion of commercial real estate loans are coming due from middle of last year through end of 2025. Many of those loans are held by smaller financial institutions. So this is something that remains a risk, something that we don't think goes away quickly and will take time to play out. This is not a liquid asset class. This is not stocks. These are office buildings, apartment buildings, industrial buildings. There are only so many transactions. We do think that this remains a topic and that that story is not yet completely written. It remains a risk to the outlook.

Brent: Yeah. And to what you just said, it's the overlay of where refinancing costs are as it relates to rates is going to be really important. And we'll have to see where we end up between now and 2025 when the bulk of those refinancings come through and the effect as it relates to the commercial real estate market.

Amy: So speaking of the real estate market, Phil, are building contractors and housing developers going to catch up with demand around the time demand starts to fall?

Phil: That's a great, incredibly cynical question. I like it. So the answer is currently no, right? We still have incredibly tight month supply of homes. Existing home sales are low because there's no homes to buy. Housing starts are, as of today, sort of above the 2019 average. So above where we were pre-pandemic, but below the post-pandemic high. It's a real explosion.

But look, the underlying part of the question is—it takes a long time to develop a neighborhood or to build a home. And often about the time there's a lot of homes on the market is when demand weakens.

What I would say, what's different about this cycle—and again, the pandemic makes this cycle different in many ways. I'm aware that people like us say "This time is different," and that's dangerous. But something that is different is that there is still so much pent-up demand. So imagine the economy weakens. What does that mean? That means interest rates fall. That means mortgage rates fall. And that means that there's a lot of homebuyers that want to buy a home—even today with these high mortgage rates—are more likely to buy a home even if the economy is weaker.

But that said, housing is always regional, just like commercial real estate. It would be naive to think that there are not regions particularly where there might be some overbuilding in anticipation of demand that's not yet there. But for now, this housing market is incredibly tight. We're a ways away from that. But it's a great question. Certainly something to watch as we move forward.

Amy: Brent, let's take this last question here. I think this is on a lot of people's minds. Are the mega-cap stocks keeping the market afloat? And will the future gains be more widespread?

Brent: I hope so. Yeah. I mean, look, the Magnificent Seven—not just last year, but since the pandemic—have done more than double what the S&P 500 has done as a group.

Phil: I think last year, 63% of the S&P 500 return was seven stocks.

Brent: So certainly, you know, very large. I think the one thing that's really important to understand, though—unlike where we were back in the technology, media and telecom bubble back in 2000, 2002, where, you know, you had some interesting and maybe speculative-type names—the quality and the profitability of some of these companies is basically unparalleled.

So it's going to be interesting to really see where we go from here. I don't think you can draw a lot of historical anomalies to where we are right now. It is certainly something that we're watching because the composition of the S&P 500 continues to be more and more into the top ten names within the index. So that certainly bears watching.

I think time will tell, but when you go back through the history of the US stock market all the way back to the mid-20s, concentration and a handful of stocks driving equity market returns has always been there, right? So I think time will certainly tell. Something that we're watching.

Again, the good news this time around is that many of those companies continue to be very, very profitable, flush with cash—and at least from an expected earnings perspective—look pretty decent. But everything as it relates to equity market investing is not necessarily about revenues or earnings. It's the price that you pay for those earnings. If you pay too much for a good company, you're not necessarily going to see those returns versus paying a reasonable price for a company is what's really important.

So again, as it relates to valuations, as it relates to where we are, we think that this year's overall equity market might be a little bit more muted than it might be in other times.

Amy: Well, Brent, Phil, thank you both so much for taking that in-depth analysis into the stock market and into the economy, as well as answering questions. And thank you to all of our listeners for trusting us to bring you this information. That's something that we never take for granted. We will be back here in February for another market update. Thanks, everyone.

Making Sense Outro Slide

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