Making Sense: July Market Update

Amy: Hello, everyone. I'm Amy Thomas, a strategist here at First Citizens Bank. Today is Tuesday, July 30th, 2024. I'm joined by Phil Neuhart, Director of Market and Economic Research, and Brent Ciliano, our Chief Investment Officer.

I want to welcome you to our Making Sense Market Update series. We've received a number of questions through FirstCitizens.com/MarketOutlook. We will answer as many as possible on today's recording. 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. If you have any questions or concerns, please reach out to your financial partner or visit FirstCitizens.com.

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

Brent: Great. Well, thank you, Amy. Good afternoon, everyone. Hope you are all well. We're going to jump right in and we're going to cover three big topics today.

First, Phil, as we always do, we're going to do a broad economic update. We'll talk about all the pertinent areas and whatnot. We'll talk a little bit about the consumer, inflation, monetary policy and the labor market. We'll shift gears, talk a little bit about the markets. We'll talk about this incredible equity-market run that we've had, fixed income, a little bit on valuations and potential headwinds as we move forward.

And then did you know, Phil, it's an election year? Unbelievable. We're going to talk about politics and the election and what's going on and give you a little bit of a historical perspective on where we've been in various election-year cycles. So with that, Amy, why don't we jump into the economic update?

So expectations coming into this year, Phil, similar to what we saw last year, was that the most significant monetary policy actions in more than 40 years, persistently high inflation that remains sticky, was going to eventually slow growth both here and abroad. And you can see in that middle column, expectations for growth down a good bit. World down almost 20%. US, Phil, almost 50% down in expectations from 2.5% down to 1.3%.

Fast forward to today, and things have certainly changed. The consumer continues to spend on services. Manufacturing services broadly has done better than expected. Inflation has started to moderate. We'll talk about that a little bit more in just a second, but broadly a much better situation today than when we entered the year.

And if we flip onto the next slide, Amy, and we look specifically at the United States, Phil, expectations for growth for this year have been falling through much of 2022 into 2023. We hit the pinnacle of bearishness basically back in September of last year—at only 0.9% for this year. And you can see, obviously, as that data came in, the consumer continued to spend. Expectations for growth have risen significantly, and we're now sitting at 2.3%. So again, the economic situation, broadly the consumer, continues to outperform in this economic cycle.

Phil: Which is really good to see from a growth perspective. And we've also got pretty good news recently on the inflation front as we flip ahead. Here we're showing both the Consumer Price Index and the PCE deflator, which is the Fed's preferred measure. And this is a calculation we're doing internally that weights more recent data over the last year heavier. So the idea is, what's the recent trend, and we're trying to capture that by weighting more recent months. And what you'll notice is—one, obviously we saw a nice march lower in inflation, but then we saw kind of this bump up earlier this year. And that was the era in which coming into the year many thought the Fed was going to cut six or seven times. And that was when that thought ended.

Now we are seeing a move down in inflation and approaching that 2% target of the Fed. Now, it's a target, right? Inflation, as you can see here, rarely trades exactly at target. It's above or below. But we are getting closer to the point where the Fed can start to act. And we'll talk about that more in a moment.

What about inflation expectations, as we flip ahead? This is break-even inflation rates, next 5 years. It's just a fancy word for what our fixed-income market is telling us in terms of inflation expectations over the next 5 years. And you can see that, first of all, it's a very volatile measure. Expectations can change very quickly in this world. But you'll notice that where we are is above that Federal Reserve's 2% target—the dark, dashed line or the thick, dashed line.

Now what's interesting is the thinner dashed line is the average from 2016 to 2019. We were in a period in which, on average, inflation expectations were actually quite a bit below the Fed's own target. We do think that that is an era that we have now departed, right? We are now in a more normalized place where inflation expectations could easily stay above that 2%—hopefully close to 2%—but above. And that, of course, has implications for higher interest rates through time as well.

Speaking of the Fed and interest rates, here we're showing market-implied fed funds futures for December of this year. So how did that change through time? What's interesting is early this year, you can see expectations by fed funds futures markets were saying seven cuts.

Brent: Which is extreme. We never were there.

Phil: We were never there. But that just gives you the degree to which people thought and market participants thought that that would be cutting. Why was that? We had had really good inflation down at fourth quarter last year. Inflation disappointed early this year, is now improving, and now expectations are for two, up to three—and even closer to three—cuts this year. Now, we have a meeting tomorrow, a July meeting. We honestly think that that should be more of a live meeting than Fed officials have indicated. But most likely no move tomorrow. But the live meeting is September. And futures are pricing a cut then. The real question is, do they cut in November and December? Or November or December? And that's the question. We would not be surprised to see two or three cuts this year.

Brent: We've been consistently in that two to three cuts most of this year. And I think it's going to be certainly interesting. If we look, Phil, though, beyond December of this year and go back one, Amy, real quick. And let's talk about expectations through September of 2025. Again, current market-implied fed fund futures are pricing in six to seven cuts between now and the September 24th meeting. And when you look beyond that, I think we had the University of Michigan 5- to 10-year inflation expectations that came in a little bit hotter than expectations at about 3%. And when I think about where economists are looking out for the end of 2025, they're closer to a 3.9% handle.

Now look, that's changed an awful lot, just like fed fund futures have changed. And certainly expectations for economists could change. But that's where they are right now at 3.4% through 2026. So at the end of the day, to your point, getting back to a more longer-term, normalized rate—where is the ultimate end for fed funds? What's that terminal value? It's something likely higher than what we've seen over the last 20 to 25 years. But certainly time will tell.

So let's shift gears and talk, Phil, about the labor market, which is critically important. What we're looking at here is the unemployment rate in the United States going all the way back to 1960. And you can see a very variable series through the longer term. That blue dotted line is the long-term average. And again, a lot of high highs and low lows. So where are we right now? Well, we hit a 50-plus-year low in unemployment back in April of 2023. And we've moved up about 70 basis points—from 3.4% up to about 4.1%. This coming Friday is jobs day. We're going to get a reading on the unemployment rate. Consensus is at 4.1, so not much of a move. Interestingly enough, when I look beyond July and I look towards next year, consensus has unemployment rate moving up to about 4.2% in 2025. But then interestingly, down to 4% in 2026.

Phil: That's wishful thinking.

Brent: Wishful thinking. So let's kind of normalize it and say a little bit higher from here. And then let's call it more of a flattening out. If you go back through this historical time series and look at any low, post-1960, we've never been in an environment where we've had a low risen modestly and then flattened out. It's sort of a higher move up.

And we're not saying by any means that we're likely to see what we saw in the 2010 era or 2020 or in the mid-80s, not at all, but maybe something more akin to the early 70s where you had a low, and you rose back up to average or in the early 2000s where again, you hit a multi-decade low and you rose a little bit back up to that 5 to 6%. So again, this is critically important that we're going to be watching what goes on in the labor market and specifically in unemployment, looking at jobless claims and continuing claims and any signs that this is starting to erode.

Phil: And, you know, this cycle has been so unique in so many ways. Maybe this time it's different. It's just we're very hesitant to say those words.

Brent: It never has. But maybe this time will be different.

Phil: And that is the tightrope that the Fed's walking. That's why they are leaning towards cutting now as they're trying to walk that tightrope.

Brent: So let's talk about what's really important, which is consumer spending here. Again, breaking down US real GDP, 68% of real GDP is consumption. Another 4% is housing. So about 72% is the US consumer. So consumption is critically important to understanding where GDP growth goes from here.

The blue line here is spending on services. The gold line is spending on goods. And as we've talked about this slide in the past, obviously both are down from the multi-decade highs that we saw back in 2021. But what I think is really interesting is the trend in services spending. And you can see—sitting at 6.8%, which is about 45% above the 20-year average of 4.7%—spending on services continues to be robust, and certainly it's slowing, but materially above that long-term average. And what's critically important, Phil, is that more than 75% of total consumption is spending on services. So as long as this line continues to trend in the right direction, we're likely to see the real GDP growth trend stay resilient. Again, time will tell. We're starting to hear anecdotal series from analysts and also from companies themselves that maybe we're starting to see some slowing at the margin. Time will certainly tell. But consumer spending on services is critically important.

So speaking of the consumer, one of the things that you and I have been talking about for quite a while is really that there's two economies going on here. There's the people in the high-income bracket and then the people below that high-income bracket. And when we specifically look at credit card delinquencies and spending, which is the gold line here, consumption has been good. We've talked about savings rates, how they've started to decline. We hit a high of 33.1% in savings right after the pandemic with all that fiscal stimulus. We are now at a point where savings rates have turned negative.

A byproduct of that is that we started to see and continue to see consumer spending on credit cards. But what's interesting is we're starting to see a little bit of stress. And on that gold line, you can see that the 30-day delinquency rate in credit cards has risen pretty significantly. We're now back up to, you know, the 2009, 2010 levels of delinquencies. And at the same time, that blue line, which is the interest rate on credit cards, is at, you know, again, multi-decade highs. So the confluence of rising delinquencies, spending more on credit and high interest rates is really starting to feed back into the consumer. And we're going to have to see how that ultimately plays out.

Phil: If you're a consumer, particularly living paycheck to paycheck, and you have explosive inflation like we did, what do you do? You access your credit card, and the rate on that credit card balance has gone up, and that drives delinquencies. So that is some of the stress we're seeing underneath the hood for the consumer.

Brent: So let's kind of bring this economic section home a little bit, Phil. Let's focus on some tailwinds and headwinds. Since I'm Mr. Positivity, I'm going to hit the tailwinds here. As we covered, service-sector employment and spending has been driving really everything. And certainly, as we just covered, service spending has been the main driver and catalyst for real GDP growth in this country.

We'll cover in just a moment corporate earnings and profitability. Corporations' earnings this year and next looking very, very robust. Net-interest margins, operating margins looking very, very good as well. And we're going to cover that in just a second. Thankfully, we're starting to see a disinflationary trend, albeit slowly. But the good news is that we're starting to see inflation, at least at the margin, subside. I think we certainly need to continue to see more movements in the right direction, and time will tell on that.

But that's leading to what you talked about, which is ultimately the greater-than-95% probability of a 25-basis-point cut here in September and the beginning of potentially a cutting cycle here. As we talked about job gains and limited layoffs, again, this Friday is jobs day. We're looking for a robust, more than 175,000 jobs. We'll have to see what that looks like. But jobless claims and continuing claims have been relatively sanguine, so we're going to be watching that. We do believe that potentially we could see the unemployment rate move up and maybe jobs starts to move to that middle area between tailwinds and headwinds, time will tell, which will be really important. And lastly, I know that we'll cover financial conditions, at least from a market-based perspective, are pretty loose, which is buoyant for the markets.

Phil: Absolutely. So let's talk about some of the challenges and headwinds. Obviously, interest rates are elevated compared to where we were prior to the pandemic and immediately after the pandemic as well. And we do have an incoming maturity wall. For example, if you look at the investment-grade credit market, we have maturities coming next year in 2026. That will be something we'll need to be watching carefully. We alluded to the idea of the softer consumer spending. We've had some mixed retail sales data, some mixed personal spending data and those increased credit card delinquencies. So there is a little bit of softening, I think, on the consumer side, we can say safely. Waning fiscal stimulus effect, those excess savings have been drawn down.

The housing market—we are seeing some slowing in the housing market. Homes are staying on the market a little bit longer. Sales data are slowing as well. Still pretty good, but not nearly as tight as it was. And I'll add commercial real estate while we're talking about real estate to that list as well. Government debt and deficits, something we have alluded to in this forum before, but we are seeing potentially a crowding-out effect by having such excess federal debt. Geopolitical tensions, obviously, globally. I won't list them all, but there are many geopolitical tensions, and it is an election year—which we'll talk about more later.

And then there's some signs of softening labor demand, right? The rate of job gains month to month remains positive, but has slowed. Additionally, when you look at things like job openings, we have seen declines there as well. So there is still a good labor market, but some of the extreme tightness is no longer there.

So let's talk a little bit about the market itself. What have we seen so far this year on the left side? US equities have been the leader in the clubhouse, outperforming internationally developed and emerging. But all three have seen pretty good returns thus far this year. Fixed income, those last two bars, are positive in total return terms, but just slightly. Right? We've seen a big move up in rates and now down. And on net, you have seen positive returns, but not dramatically positive.

When we look underneath the hood in US equities, this is something that has changed since the last time we spoke, last time we showed this table, which is, yes, large-cap growth is still the leader in the clubhouse. But look at how much tighter these things are, right? Small cap has really closed the gap. Why is that? We've seen pretty extreme small-cap outperformance in recent weeks.

Brent: Yeah, just this month alone, right, the S&P 500 has returned basically zero, and the Russell 2000 is up 10%. Right? So much of what you're showing there, that 9.7 in small-cap value and 10.5 in small-cap core, really happened in the last 25 days.

Phil: That's right. And something we've talked about so much on this call for a year-and-a-half, probably more now, has been the concept of broadening. Well, we are now seeing broadening. Does it stick? One month does not make a trend, but there is no question we've seen some pretty extreme broadening outside of just those largest stocks.

So what have we seen on trend, as we flip ahead? Since October of 2022, up 51%, still near all-time highs. Since last October, up 31%. So to say that there's not some good news pricing to the market is probably a little bit naive. But we have had quite a run and something to remind us all that this is an environment in which we've had geopolitical tension, election noise, concerns around deficits, and the market has performed well. Risk markets are going to return to things like company earnings and what you're willing to pay for those dollar of earnings.

Brent: Yeah and when you look at this chart—it's so funny, I remember when we covered this back in, you know, late 2022, and everyone was asking us whether or not the October of 2022 low was the end. And where we're going to go from there, and it's interesting to see how much we've risen from there.

I mean, it's certainly not a straight line, but what I find incredibly interesting, Phil, is we've gone more than 356 days, trading days, without a greater than 2% daily correction. That is the longest trend, right, since the 2004 to 2007 period of time. Now, on July 24th, the equity market, the S&P 500, sold off 2.3%. So it ended that long run. But at the end of the day, the fact that we had gone that long and that far without a major correction is pretty amazing.

So, again, maybe that portends in the second half of this year that we might see a little bit of volatility as the market starts to broaden out in turn—which we believe is a healthy thing. And plus, to your point, coinciding with an election and some other geopolitical things, we're likely to see a little bit more volatility, we think, here in the second half than what we've seen to date.

Phil: Right. So let's dig into that narrow-versus-broad-market argument. Here we're showing both equal-weight and market-cap weighted S&P 500. As a reminder, market-cap weighted, which is the gold line, that is where a large company has a bigger weight in the index. That's the index you hear reported day to day. Equal weight, all 500 companies have the same contribution, right? So it's a good measure of comparing these two of breadth. What you'll notice is on trend, market-cap weighted has just dominated since, what, first quarter of last year. But you will notice that we have seen that spread narrow some in recent weeks. Why is that? Things like mid cap and small cap have outperformed, even though, of course, S&P 500 is a large-cap index. We have seen some narrowing there as the Magnificent Seven, particularly, have underperformed. But nonetheless, the market still remains not too far off all-time highs.

So let's dig in on small cap for a moment as we flip ahead. So what are drivers of small-cap stocks? Well, one thing is that small caps are interest rate sensitive. So here we're showing the 2-year Treasury versus the Russell 2000, and you'll notice that they often move in opposite directions. The most recent, big downward move in Treasuries due to some good news on the inflation front—lower than expected—really drove real outperformance of small caps.

So there is a sensitivity there. This is something we're watching. If reach remain low—or particularly the front of the curve were to fall faster than expected even—that could be good news for small caps. Obviously, a lot of good news has been priced in in recent weeks for small caps. Not that things just march up in a straight line, but this is a relationship that we think is worth keeping an eye on. And the recent move down in rates helps to explain why small caps have outperformed.

Brent: Yeah. And from a small-cap perspective, you know, we had talked about in the past and we'll get into valuations in just a second. I mean, the Russell 2000 relative to the Russell 1000 have been trading more than two standard deviations cheap relative to large-cap stocks. That doesn't mean that small cap is cheap, right? It just means that large-cap stocks have gotten pretty expensive—so from a differential perspective. Usually when you start to see some of those wider valuation differentials, you start to get this little bit of a snapback, and returns and valuations come more in line.

So speaking of valuations on the next slide, what we're looking at here is the next-12-months P/E ratio. In essence, what is an investor willing to pay for a dollar of next-12-months earnings? And what you can see on the gold line here is that valuations have gotten a little bit extended. We're trading at roughly about 22-times forward earnings, which is a little bit more than one standard deviation expensive. Again, not nosebleed levels. I mean, we've been here before. Look at what we had seen in the 2021 period—and certainly back in the late 90s through 2000s where we got significantly more expensive. But on balance, despite incredibly good corporate earnings and profitability—which we'll talk about in just a second—the equity market is trading at a higher multiple than what we've seen in the past and certainly a little bit higher than average.

When we break that down a little bit more on the next slide, what I find very, very interesting, Phil—the gold line here is those same valuations, but only looking at the top 10 stocks. The blue line here is the residual 400 top stocks in the United States.

Phil: 490.

Brent: 490. I'm sorry, 490. I can't do math this morning. At the end of the day, when you're looking at this line, certainly the largest top 10 stocks are trading at more than 30-times forward earnings, where right now the residual 490 stocks are only trading at about 17-times forward earnings, which is about average for the 490. So again, valuations in much of the S&P 500 are not stretched. It's really the heavy top-weighted 10 stocks that are driving aggregate valuations for the S&P 500.

Phil: And this is something that we've been showing previously, and we showed it as an argument that there's room for broadening. Well now it does appear there is some broadening. It's interesting that there remains room, so it is good to see broadening. Of course you want to see broadening at an uptake. But, nonetheless, seeing some participation outside of just those largest names has been good to see. And from a valuation perspective, there's potentially more room.

Brent: Absolutely. So a question—on the next slide—a question we get an awful lot, Phil, is while the market's really going gangbusters, multiple expansion is happening and the equity market keeps going up, can it continue to rise? And I think the one thing that gives us a little bit of comfort is corporate earnings and profitability. And when we look at these numbers here, right, the expectation for fiscal year 2024 is now sitting at almost 11%, Phil. And this number keeps rising, right? This number got revised back on Friday, July 26—up from 10.6% to 10.9%. So about 30-basis-points increase.

Phil: And why is that? In earnings on net, S&P 500 companies have beaten so far. So it starts to pull up those numbers.

Brent: That's right. And we're only, basically, after this week, halfway through earnings season. So a lot more to report and a lot more to go. But so far, so good. What I think is really interesting is—look forward to 2025 earnings growth. We're looking at almost 15%. And again, this number went up as well from about 14.5% to 14.8%. So analysts have not yet taken a sharpened pencil to next year's earnings. And again, comparing them to the average earnings of roughly about 7.5% since 1950, you're talking about more than 40% higher than the long-term average this year—and almost double the long-term average next year. So again, fundamentals look pretty darn good in S&P 500 companies.

And when we look at the chart on the right, where we look at next-12-months operating margins, sitting at 17.3% is incredibly robust. So again, the fundamental underpinning from an earnings and profitability perspective is nice to see and I think is supporting the equity markets from a fundamental perspective. And we've got to hope that these numbers continue to play out as we go through this earnings season and to the rest of this year.

So let's talk about another interesting stat. When we look at the top 3,000 companies, right? We've hit a pretty high number of 25% of companies have a gross margin greater than 60%, right? Which is just an incredible thing to see. So the underlying resiliency, the underlying profitability—and it's interesting time and time again, I believe analysts underestimate the resourcefulness and the ability for companies to drive earnings and profitability—continue to increase revenues. Operating margins and gross profit margins continue to look good. And again, we've got to hope that this trend continues for the equity markets to make higher highs.

Phil: Yeah, Corporate America is pretty dynamic. And by the way, when we talk about broadening, this is another argument for it, right? 25% of the top 3,000 have very high gross margin. Look at how that compares to history. It just shows there's good companies out there. They're not just in the top 10 names, largest names in our stock market. So let's turn ahead to our price target. As a reminder, our price target is next 12 months.

Brent: Yeah, it's not end of year.

Phil: Yeah, we're looking ahead to late July next year. We have increased our base case today to 5,900 on the S&P 500. That's roughly 7.9% from intraday yesterday. In that base case, we are taking a bottom-up consensus earnings expectations for the next 12 months—not adjusting those, but being pretty conservative on months 13 to 24—only 8% earnings growth. That's well below consensus and keeping the multiple fairly flat. So this is not an overly aggressive base case, but you still get some nice gains from where we are trading yesterday.

In the bear case, we have about 20% drawdown. That is where we are downwardly revising earnings expectations pretty materially—5%—and then only having about 7-ish% earnings growth in months 13 to 24, and of course, multiple contraction. We do have a robust multiple. That is certainly a way the bear case plays out.

The bull case, this is Goldilocks playing out. We have upward revision to next-12-month earnings revisions—earnings that could obviously happen, and the earnings are coming out positive, followed by 10% earnings growth. So still below sort of the extreme out-year view of bottom-up analysts and still very slight multiple expansion but not much. So that is an 18.9% gain from yesterday.

Brent: What I like about the base case here is that we are not talking about further multiple expansion in this number. We are talking about growing into 5,900 from an earnings growth perspective, which is, I think, really important, which is, again, critical to see corporate earnings and profitability meet the expectations and the lofty expectations that have been put out there. But I think it's a pretty reasonable base case and something that I think is certainly obtainable over the next 12 months.

Phil: That's right. So let's talk rates for a little bit here. This is the yield curve as a reminder, the Y axis is US Treasury yields, or the vertical axis. The horizontal or X axis is the maturity date of those Treasuries, 1-month all the way up to 30-year. And you can see the blue line here is where we started the year, and we've had quite a ride. But you can see where we are as of July 25th.

The yield curve has seen in some ways, you know, further out in the curve, a pretty symmetrical shift up, but we are starting to see it flatten a bit, right? You can see that the 2-year hasn't moved quite as much as the 10-year. A lot of that has happened in recent weeks. The real question is what's the shape of the yield curve going forward? Our instinct is with the Fed cutting that most of the movement you see is in what we call the front end of the yield curve—in other words shorter-term interest rates—and, yes, hopefully that has some impact on longer-term interest rates, but unlikely to have as much. That can help the yield curve to uninvert.

So as we move ahead, there remains opportunity and yield within fixed income. This is a chart we show, and we show it intentionally every month. And just a reminder of how far yields have come from end of 2021 or beginning of 2022. Aggregate bonds still yielding 4.8%, well over double what it was yielding. Look at the 10-year, look at the 2-year Treasury, look at muni bonds—3.6% versus 1.1%. We're talking about multiple higher.

Brent: Yeah, tax-equivalent basis. If you're on the highest tax bracket at all, Medicare surcharge, you're in excess of 6% on a tax-equivalent basis. So it's pretty attractive.

Phil: That's right. And in case any of you have forgotten, it is an election year, and we want to address that in a brief manner here. So what is the state of play? Here, we're showing predicted odds—not that predicted odds are always correct, but we're market people. We tend to like using market-related odds versus polls.

If you look at Democratic Party candidate and Republican Party candidate odds of winning on June 1st it was a coin flip, 50-50. After the presidential debate, that shifted closer to 57%, pushing 60% Republican. After the presidential assassination attempt of former President Trump, that moved up even further—64% in favor of Republican. And President Biden withdraws from the 2024 election, you start to see it move down, right? Down to 58% Republican, 42% Democrat. And as of July 25th, these numbers have moved to 54-46. So moving closer to that starting point, still favoring Republicans.

Brent: Yeah, and I think, look—there's a lot of time between now and November. A lot of voters on vacation. A lot of voters on vacation. This will certainly come more into the spotlight. And the one thing that I think we can both agree on is these numbers are going to change. So a lot to think about.

But again, if we go back and we think about the disposition of our country, we're roughly a 50-50 country. And if I go back to the 2016 election, and I look at sort of the votes that drove the Electoral College, you had only about 56,000 votes that separated the two candidates in 2016. In 2020, you had about 76,000 votes. So again, you're talking about 0.04% of the voting public that actually swung who was in office. So again, time will tell. And we're ultimately, no matter what we show or what we talk about, we're actually going to have to wait to after Election Day to find out who actually won, and it should be again, like we normally see, a relatively close race.

Phil: That's right. So Brent, what about the market performance in past elections?

Brent: Absolutely. So if we take it back to something that we're probably better at, which is understanding markets, is when we think about markets in election years with the incumbent president running for re-election. So that's an important point to the slide—is when the incumbent president is running for re-election, the equity markets have done well, on average about almost 16% since 1944.

Interestingly, we'll see because the incumbent president was running for re-election, no longer running for re-election. So how this changes things, time will certainly tell. I would argue, though, when you go back in history and you look at the S&P 500 and you look at very positive first half of the years—on average, the second half has been positive as well, and full year has been positive. So if we take it outside of the election stuff and look at more of a longer-term dataset where we have more data points, we still believe that this year for the S&P 500 will end on the positive note, knock on wood. And we'll just have to wait to see how the second half shapes up.

Phil: And look, the thinking here is, and something we've mentioned prior—we've shown this slide before—is that an incumbent president is going to do everything they can to boost the market, right, versus a second term president, they're thinking more about where their presidential library is going to be, right? Maybe not as concerned.

But, you know, with presidential analysis relative to markets, take it with a little bit of a grain of salt. Remember that some of those second-term presidents, well, 2000, the end of the tech bubble. 2008, the Great Financial Crisis. These are end of second-term presidents. That really skews data. And I don't think either of those have much to do with it being an election year. It had to do with the fact that we had a dotcom bubble and we had a housing bubble. And those start to unwind in certain cases even before the election year. But nonetheless, this is what we've seen historically.

Brent: Absolutely. And on the next slide, we get asked all the time, "I'm really concerned about who's going to be in office, and how is that going to affect markets." And again, we've said time and time again, that we believe that fundamentals will ultimately be the governing factor, right? The economic environment, the fundamentals, not necessarily who's in office, whether that's the president or the composition of Congress

But what you can see here is going back all the way to 1872, the underlying disposition of government. And you can see, let's take that very first gold bar, and that's actually where we are right now with a Democratic president, a Democratic Senate and a Republican House. Incredibly small sample size of 5 years, but it's been the best performer, about 15.7%. We're basically there—a little bit above that right now. So that's been good. And then when you kind of look across the board, it's very flattish, right?

With most other dispositions, whether it's a Democratic president, all-Republican Congress, et cetera, et cetera. When you look across the board, if I take even beyond this slide and I just look at either a Republican president or a Democratic president over the same time series—it's roughly 11% annualized return for a Democratic president, close to 10% for a Republican president.

So at the end of the day, you might not want to hear it—it doesn't really matter, in our opinion, who's in office and who wins the election. It shouldn't really drive intermediate-to-longer-term the results of the equity markets. Again, fundamentals should play out. Corporate earnings and profitability, multiples, the economic environment, the jobs market that we talked about, the labor market, consumer spending—we think is what's going to drive the ultimate disposition of our economy, as well as the equity market.

Phil: Just look at the last couple of years of performance. That was driven because margins were recovering. It wasn't because the market looked to who was in power in Washington. It was driven on fundamentals.

Brent: Absolutely. So I know, Amy, we have an awful lot of questions. Why don't we take us home here?

Amy: Yeah, and just a reminder to everyone who may be interested, we have information throughout the month for all of our subscribers. If you're not already subscribed, you can hit the QR code and answer a couple of questions and get signed up. That'll get you signed up for a weekly video from Phil at the start of every week on the economic outlook for the week ahead and then various publications throughout the month—every time the Fed speaks and inflation information as well.

So let's jump into questions. Phil, this first one is for you. Of course, there's a Fed meeting tomorrow. A lot of conversations recently about the Fed potentially could cut rates tomorrow instead of September. How are you feeling about that going forward?

Phil: We do think, given inflation data, et cetera, that tomorrow's meeting should be a live meeting. But the Fed speakers have made it pretty clear, communicated pretty clearly it is not. So fed funds futures are pricing essentially no cut. So the surprise would be if they were to cut—that would be quite a surprise to the marketplace. And you would see markets react dramatically to that.

On the other side, though, September is basically fully priced at this point that they do cut. So whether it's July or September, the bias is towards cutting and most likely more than once this year, likely two or three times. If they were to move tomorrow, that'd be a welcome surprise to risk markets. I think we'd see a real move there in both risk markets and rates. But that is just not what's been communicated. It seems pretty clear that they would like to lay the groundwork tomorrow for a potential September move. So the statement and press conference are going to be very interesting and carefully outlined. But September appears to be the live meeting.

Brent: Yeah. I mean, I think market participants are absolutely going to be parsing over the words. And to your point, I would find it hard to believe that the Fed would deviate from how they're telegraphing things, especially given everything that we've been through and the inherent variability that you covered very nicely on market-implied fed fund futures and where we've been. I think they're going to stay on point.

Phil: There were many Fed speakers that had an opportunity to push us that direction, and they did not, en masse at least.

Amy: Brent, speaking of the Fed, they do have a dual mandate. The other half of that mandate is low unemployment. Recent employment data has showed a tick up in unemployment. Is that a precursor to a larger problem?

Brent: At margin, I would say at this point, not necessarily, right? But I think we have to take a huge step back and bring this up 50,000 feet. We are coming off of the lowest level of unemployment in more than 50 years. Like I said, in April of 2023, we had a low of 3.4%. Jobless claims, continuing claims are still relatively low, right? And we don't see a ton of velocity there. Job creation still remains robust. We're looking for a pretty decent number and a number over and above the level that we need to keep unemployment from moving higher.

So to answer the question, Amy, at this point, are we concerned? No. But to the slide that we showed about the unemployment rate through history, it would be naive to believe that we will sit at this low level of unemployment for a very prolonged period of time—i.e. not move up more significantly and just move horizontally. Is it possible? Sure. Anything's possible. But when you go through and look at this data series, even if you didn't understand it, and I told you, "No, no, no, we're going to stay at 4.1% for the long term." You wouldn't believe it because it's never happened in the data series that we have.

So we do believe at some point in time, we will move closer to that long-term average. To what velocity and when? Unsure right now because things still look okay. Time will tell, but our gut tells us that if something is going to happen, it's probably going to start in the labor market, which will start in the corporate side of things.

Amy: Phil, let's talk about rate cut timing and the housing market. There's been a lot of argument that the housing supply is so tight because people have locked in lower rates. If the Fed starts cutting rates, do you think the housing supply will start to move back up in the favor of the buyers?

Phil: Yeah, it's a good question. Something we highlighted, I believe it was last month. Actually, the supply is already moving up. Whether you look at month supply or inventory of homes, you are seeing homes on the market for longer. You are seeing some price cuts anecdotally—doesn't mean prices are going down, just cutting from list price.

What we've seen so far, though, is that home price appreciation has continued. In fact, we get some fresh data on that this morning that we'll have to analyze. So the truth is we already are seeing a loosening housing market. Now the Fed cuts, the real question isn't—the Fed does not control mortgage rates. The Fed controls the overnight rate. The real question is what happens to long-term Treasuries, which are actually what mortgages are.

So if the 10-year were to move down, does that bring mortgage rates down? Let's say it does. I'm not so convinced it does, but let's say it does. Well, actually more demand comes into the market, right? Because there's going to be those that say, you know, "I'm interested in entering the market." But at the same time, there are those who have been wanting to relocate but have not because they want to leave their low mortgage for a new. So what you would see is there would be a demand boost, potentially a supply boost as well. How does that meet equilibrium? I think it should be messy in the short term. But eventually, like all markets, the housing market will find equilibrium. But the truth is, we're moving a little bit closer towards that already. Even with mortgage rates elevated, you're seeing home sales weaken to some extent in recent months. And additionally, supply has risen.

Brent: But make no mistake, Amy, we're a long way from bettering affordability. The median home is still about $445,000. Mortgage rates are high. And even if they do fall, they're still high. So at the end of the day, for the average consumer or younger person or whomever looking to buy either that first home or move to another home, the cost of homeownership is still high and is likely to remain high for quite some time, even if we have movement in the right direction.

Phil: That's right.

Amy: I don't know if you guys have been watching the Olympics, but I sure have. And it's so nice to see so much of the world coming together, but it's also a reminder of everything that's going on in the world. And with things back here at home, November's election that we talked about, geopolitical concerns around the world, should we expect to see higher volatility in the second half of this year?

Brent: Yeah. Well, Amy, I've been watching the Olympics too, and I think I'm going to sign up for the two-meter race. That's probably about as far as I could run. But yeah, look, geopolitical events and geopolitics are ever-present, right? It's nothing new. It is interesting how much risk markets have shrugged off geopolitical events. I find that pretty interesting. Look, we talked about how we've gone more than 356 days without a greater-than-2% trading day correction. And we just had one last week. Is there going to be more volatility? If I was a betting person, I would say yes. And I'd say volatility in risk markets, volatility in rates. I think we're definitely going to see more of that in the second half.

Does that mean that you shouldn't be investing in risk assets or you shouldn't have a thoughtful, diversified portfolio or change your plan because of that? Absolutely not. You have a thoughtful, comprehensive financial plan, and you're allocated in a certain way for the long-term results that you're seeking to achieve.

So please, whether it's geopolitical events, an election, there's always something. As you say really well, Phil, there's always this wall of worry that would get you out of your investment protocol. You can't do that. You have to turn a blind eye to those things and be thoughtfully allocated, have that financial plan, invest for the long term and let a lot of this stuff just pass you by. You'll be better for it, I believe, in the longer term by ignoring those things. Not to minimize or de-emphasize the underlying global importance of these events, but from an investor's perspective, you really have to turn a blind eye to it and not worry about it if you want to be successful, in our opinion.

Amy: Well, Phil, Brent, thank you so much for the in-depth analysis of the bond and equity markets and taking that extra step in going through the election. I just want to thank everyone for participating and submitting your questions. As always, thank you for trusting us to bring you this information. That's something that we never take for granted. And we will be back again with you next month. Thanks, guys.

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

Important Disclosures

This material is for informational purposes only and is not intended to be an offer, specific investment strategy, recommendation or solicitation to purchase or sell any security or insurance product, and should not be construed as legal, tax or accounting advice. Please consult with your legal or tax advisor regarding the particular facts and circumstances of your situation prior to making any financial decision. While we believe that the information presented is from reliable sources, we do not represent, warrant or guarantee that it is accurate or complete.

Your investments in securities and insurance products and services are not insured by the FDIC or any other federal government agency and may lose value.  They are not deposits or other obligations of, or guaranteed by any bank or bank affiliate and are subject to investment risks, including possible loss of the principal amounts invested.

About the Entities, Brands and Services Offered: First Citizens Wealth™ (FCW) is a marketing brand of First Citizens BancShares, Inc., a bank holding company. The following affiliates of First Citizens BancShares are the entities through which FCW products are offered. Brokerage products and services are offered through First Citizens Investor Services, Inc. ("FCIS"), a registered broker-dealer, Member FINRA and SIPC. Advisory services are offered through FCIS, First Citizens Asset Management, Inc. and SVB Wealth LLC, all SEC registered investment advisors. Certain brokerage and advisory products and services may not be available from all investment professionals, in all jurisdictions or to all investors. Insurance products and services are offered through FCIS, a licensed insurance agency. Banking, lending, trust products and services, and certain insurance products and services are offered by First-Citizens Bank & Trust Company, Member FDIC, and an Equal Housing Lender, and SVB, a division of First-Citizens Bank & Trust Company. icon: sys-ehl

For more information about FCIS, FCAM or SVBW and its investment professionals, click here:

FirstCitizens.com/Wealth/Disclosures

SVB.com/Private-Bank/Disclosures/Form-ADV

©2024 First-Citizens Bank & Trust Company. All rights reserved. Silicon Valley Bank, a division of First-Citizens Bank & Trust Company. Member FDIC., First Citizens Wealth is a trademark of First Citizens Bancshares, Inc.