Making Sense: July Q&A

Amy: Hi. I'm Amy Thomas, a strategist here at First Citizens Bank. Today is July 15th, 2024. I'm joined by our Chief Investment Officer Brent Ciliano and Director of Market and Economic Research Phil Neuhart. Each month, we come to you with questions we're hearing most often from our clients. If you'd like to submit a question, you can visit FirstCitizens.com/MarketOutlook. By the way, 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.

So Phil, we got a brand new CPI report last week that surprised a lot of people. Can you get us up to speed on that and what your thoughts are there?

Phil: So certainly, the numbers came in weaker than expected. I think the disinflationary trend really does appear to be in place, and markets are reacting as you'd expect it if it is in place. The 2-year—just Thursday and Friday of last week—the 2-year Treasury yield fell 17 basis points.

Brent: Yeah.

Phil: The 10-year Treasury yield fell 10 basis points. So the front end of the curve—shorter rates—fell more, but still really massive moves around the curve, although the yield curve did [see] steepening. And we also saw moves in the equity markets that were pretty fascinating. So we've had this incredibly narrow market thus far this year and last year. We've all heard the Magnificent Seven—or the Magnificent Five—really pulling markets higher. But what we saw late last week on Thursday and Friday was real outperformance of things like small cap. And the small-cap index outperformed the S&P 500 by 5% in just 2 days.

Brent: It was pretty impressive.

Phil: 5% in 2 days. That's pretty remarkable. If you look at the equal-weight S&P 500 where all 500 companies have the same weight versus the cap weight—the equal weight outperformed the traditional S&P 500 by 2.3% on just Thursday and Friday.

Brent: Oh, yeah. Just on inflation day alone.

Phil: Huge amounts. We've all been waiting for broadening, and 2 days does not make a trend, but we certainly saw that. And a lot of that was this inflation data coming in weak. Small-cap stocks are viewed as more interest-rate sensitive. If rates come down, that may be good for small caps is the view of the market.

Brent: Absolutely.

Amy: Brent, there's upcoming Fed meetings. What are your thoughts on where rates could go from here?

Brent: Yeah. Well, I mean, we still have a meeting in July, Amy, and it should be in play, but we don't think it's in play. And certainly with Chair Powell's commentary we don't think it's really in play as of this point. Certainly, we think September is the most likely first cut that we'll see, and certainly fed fund futures are pricing that in. Right now, slightly more than a 90% probability of a 25 basis point cut in September. Time will tell.

We did see expectations overall for fed fund futures change for full year to about 2.5 cuts for fiscal 2024. But, again, the preponderance of data and the evidence that will come—in between now and the end of this month, the end of the next meeting, as we get into the fourth quarter—will certainly drive where we actually end up, but it does look like September being the first cut.

Phil: Yeah, this disinflationary data we saw last week is really starting to shift expectations around everything from the Fed to Treasury yields.

Amy: So, Brent, with the significant moves in the markets, how's the valuation side for that?

Brent: Yeah. Certainly, as Phil alluded to, the equity market has been on sort of a rocketship. We're up 18.6% year to date.

Valuations have gotten a little bit stretched, Amy. Forward P/E, right—basically, expectations of what investors are willing to pay for a dollar of next year's earnings—are basically at 21.4 times, which is pretty significant. If you compare them to 5-year averages, it's been about 19.3 times or 10-year about 17.9. So a little bit rich, but not nosebleed.

Phil: And what's interesting is we're talking about that broadening of the market. So much of that expensiveness in the market is the largest stocks. Something we've been talking about in recent webinars is, yes, the top 10 stocks of the S&P 500 are expensive versus their own history, but if you look at the other 490, they really aren't. So maybe there is—in an uptake—room for broadening, assuming fundamentals remain in place. Of course, fundamentals remain important.

Brent: I think the one thing that certainly what we're going to continue to see, Amy, is increased volatility, right? We, you know, we have a lot of economic data and a lot of economic volatility. We also have geopolitical events. We have an election coming up in November. So certainly, you know, while things look good on the surface, we are expecting a little bit of volatility going forward through the rest of this year.

Amy: And speaking of that level of fundamentals, what are your expectations for earnings season in Q2?

Brent: Yeah. So knock on wood—so far so good. For second quarter, I mean, it's certainly early. We've only had about 5% of companies report. About 9.3% expected quarterly earnings growth, which is fantastic.

Phil: That would be the highest since first quarter of 2022. That would really be a great number.

Brent: Exactly. Full year, we're looking at about 11%, Amy. Next year, we are still sitting at 14.4% for fiscal 2025. Certainly, analysts are going to sharpen their pencil on that number. And, Phil, we've talked about that a lot. We expect that number to come down, but very robust, Amy.

Phil: Yeah. And thinking about this earnings season, one, that 9-percent-ish growth, that's a higher bar to clear. We've had some earnings seasons that might have been a little easier for companies to beat, but analysts just did not aggressively cut estimates coming into this earnings season. There's a higher bar to clear, which makes it kind of interesting.

It is going to remain a margin story, though. Earnings growth is expected to outpace revenue growth, and that means margins. And really what you're hearing folks talk about—and we're watching it carefully—is not just the stocks, but the fundamentals. Do we see a broadening out from those biggest companies that we know that they're doing great?

Brent: That's right.

Phil: What about other companies? What about sectors like healthcare and energy? And that's going to be a real focus, I think, this earnings season, which certainly—tying back to your previous point—could drive volatility, given the expectations are higher.

Brent: Yeah. And hopefully, again, knock on wood, we do see that broadening out, and we think about exposures beyond the Magnificent Seven. Again, we hope that that would continue and certainly with the recent movement that we saw post those inflation prints—let's see if that continues through the rest of this year.

Amy: Thanks for watching. We hope you found this information helpful. For more information, please visit FirstCitizens.com/Wealth.

Making Sense Market Update Outro Slide

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

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