Making Sense: February Market Update

Amy: Hello everyone. I'm Amy Thomas, a strategist here at First Citizens Bank. Today is Thursday, February 27th, 2025. I'm joined by Blake Taylor, market and economic research analyst, and Brent Ciliano, our chief investment officer. And I want to welcome you to our Making Sense Market Update series. Each month, our team brings information to you regarding current markets and the economy to help you make your financial decisions. As always, the information you're about to hear are the views and opinions of only the authors at the time of recording and should be considered for educational purposes only. This information should not be considered as tax, legal or investment advice. Brent, with that, we're ready to go. So I'll turn it over to you.

Brent: Awesome. Well, thank you, Amy. Good afternoon, everyone. Hope all of you are well. As you can see, Phil Neuhart is traveling on the road meeting clients, and I'm joined by the always thoughtful Blake Taylor. Thank you, Blake. I appreciate you jumping in. So we've got a lot to cover, Amy. So let's talk about what we're going to hit. So we're going to start off and give you a high-level overview of what's going on in the economy. We're going to hit all the key points, Blake. We'll hit inflation, interest rates, monetary policy. We're going to certainly give a pulse check on what's going on in the economy from a broad perspective. And then certainly there's a lot of activity going on in the labor market, specifically with the activities of DOGE and whatnot. So we're going to talk about the impact of that.

We'll talk about the labor market and consumer spending. And then I think we're going to shift gears, talk a good bit about the equity markets and what's going on. Certainly, it's still the beginning of the year and we're getting a lot of questions from clients on, you know, Brent, Phil, Blake, when should I be putting my money to work? Should I be putting my money to work? How should I be putting my money to work? So we're going to cover that and we'll certainly talk about rates and fixed income. So let's jump in, Amy, and let's talk about the economy and let's start and do a broad pulse check here.

So at a high level right now today, Blake, the overall US economy is doing quite well. Certainly, we're going to talk about the path forward and what's going on and some of the things that could potentially get in the way of that. But why don't we go across the top and let's start left to right here. Let's talk about economic activity. So back at the beginning of the fourth quarter of last year, broad economists thought that our economy in fiscal 2025 was going to grow at about 1.8%. Fast forward to today, Blake. Broad economists see our economy growing this year, almost 50 basis points higher than that at 2.3%. Again, nicely above that potential long-term growth rate for our economy, which is good to see.

From a labor market perspective, if we think about job creation, again, at the beginning of the fourth quarter of last year economists thought that we would do about 121,000 jobs per month in fiscal 2025. That's edged up despite everything that's going on with DOGE and activities. That number now sits at about 130,000 jobs. And we're going to get into it in just a little bit. You know, it's nicely at the high end of the range of that break-even rate that we need to see to make sure that the unemployment rate doesn't continue to tick up.

And speaking of unemployment in that rate, again, sitting at about 4.4% back at the beginning of the fourth quarter of last year. That's kind of ticked down to about 4.2%, certainly above where we've been, right, with these, you know, multidecade lows that we've seen in the unemployment rate. But again, something that is better today than it was back at the start of the fourth quarter. And I think what's on everybody's mind is, and we get asked all the time, Blake, is are we going to have a recession potentially over the next 12 months? Well, when I look at consensus, again, at the start of the fourth quarter of last year, that was sitting at about 30%. That's actually ticked down to only about 23% probability over the next 12 months. So across the board, whether it's economic growth, the labor market and the overall aggregate probability of recession, things are in good shape right now, Blake.

Blake: Yeah, a view that we've been advancing out there is that the economy is strong, period. But we're also contending with elevated uncertainty. And what we see at the bottom here is a significant driver of that. And that's inflation is still too high. So remember, inflation is supposed to be 2%, or close to it, as close as we can get. Right now, the latest inflation rate from the CPI index is 2.8%. Unfortunately, that's moved up from 5 or 6 months ago, when the expectation was for inflation to be 2.2% this year.

Similarly, that next tile over, the core PCE index, that's not really an inflation rate you hear about much the newspaper, but that's what the Federal Reserve tries to target for 2%. Economists thought that was also going to be 2.2% for 2025. But they've now moved that up to 2.6. So those things are moving in the wrong direction. And lastly, what about interest rates? The expectation for 2025 a few months ago was that the Fed funds rate would be 2.9%.

Brent: That's a lot of cuts.

Blake: And now that's moved up to 3.8%. So as you said, strong economy, as we've seen that across the top, we've had these kind of dissonant themes between we have a strong economy looking back and maybe looking forward a few months or even this year, but there's a lot of elevated uncertainty surrounding inflation and also the policy outlook.

Brent: Yeah. So let's move forward, Amy, and jump in and let's get under the hood a little bit on US growth. What we're looking at here is the quarter-over-quarter, sorry, the quarterly look at that year-over-year change in growth and sort of that trajectory of US growth. The dark blue bars here are what's actual. The light blue bars are consensus expectations for growth. And that gold line across is sort of what we were just talking about, like, what is the potential growth rate built into our economy? It's sort of that Mason-Dixon line that we need to sort of stay above as it relates to being able to see our economy grow at a thoughtful trend rate.

And what you can see is that today, again, as we just said, overall, we're sitting about 2.3% forecast for this year. And you can see consensus believes that we're going to be above or right roughly at the potential growth rate. So despite all the headwinds and what you just talked about, Blake, whether it's headline inflation or core inflation or potentially what's going on in the labor market, for right now broad economists still believe that we will be growing at or above potential growth, which is good to see. Now, certainly we've got some recent now-cast data from like the Atlanta Fed GDP. Now, looking at this quarter, that number has come down from about 2.6 to about 2.3. So we expect that these forecasts will change as we go through the year. But for right now, again, looking at real growth, that's at or above potential, which is good to see.

So on the next slide, Amy, let's break this down a little bit and let's talk about manufacturing and services. Dark blue line here is manufacturing. Gold line is services. And what I want to specifically look at is on the right side here. And let's start with manufacturing. You can see that from 2023 through 2025 or the early part of '25, we had manufacturing in contraction. So above the line, above this 50, is in expansion, and below the line is contraction. You can see that line has been below the 50.0 line, so basically indicating that manufacturing had been in contraction for much of the last 2 years.

Interestingly enough, we put these little diamonds here that are sort of the estimates of what we're going to see next week. We're going to get readings on both manufacturing and services on the third and the fifth, respectively. The indication is that we're going to see manufacturing continue to tick up into expansionary territory, which is good to see. Unfortunately, you can see that on the gold line, services has been broadly in expansionary territory, which is certainly a big driver of our economy. We spend more on services than we do on goods and whatnot. So by and large, seeing the services economy continue to do well is important. That initial flash reading that we're likely to get for February sees a rather significant contraction down to below the line, so time will tell. We'll have to wait for that reading. But it seems like at the margin, manufacturing is accelerating a bit, and services is decelerating. So we'll have to wait. So a little bit of a cooling broadly in our overall growth trajectory if the readings were to come through.

Blake: And feels a little more uncertain as we kick things off.

Brent: Exactly. Broad theme.

Blake: Well, let's change gears a little bit and move away from growth, and let's start talking about inflation and prices. And what we're going to do here is we're going to talk about where we've been, where things stand with the inflation rate, and then we're going to go over what's the market and what are consumers expecting. And then we're going to bring it home with what does this mean for the Fed and policy rates. So to start off, let's just take a step back and remind ourselves of where do we stand with inflation and where has it been. Inflation started to surge in 2021 and through 2022, as we know. What we're showing here is with this dark line, this is the year-on-year CPI inflation rate.

Brent: This is in the paper.

Blake: This is the one you hear about in the paper. It's the one that that you'll see in your cost-of-living adjustments the government uses and so forth. That has had a slower move up in 2021 and 2022 and a slower move down. What we've seen in this dotted blue line, that's a much faster read. That's what we call the 3-month annualized rate. So just look at the last few months and extrapolate that. Pretend that's the rate for the whole year.

Brent: It's a good it's a good look ahead as to what we what might be coming from an inflation perspective.

Blake: And what we've seen is it has bounced around quite a lot. It shot down in 2022 and then kind of moved sideways. But we've had a few false reads. Look at how it hit 2% in 2022. Look at how it came below that gold 2% line just about 6 months ago. What we've seen now is it is shooting back up. The last few months of inflation have been printing at a much faster rate than that year on year. So what we really care about is that dark blue line, but what we're seeing is inflation is moving in the wrong direction.

So what does this mean for us? Inflation is notoriously impossible to forecast, but what we can see here is that for 4 whole years, inflation's been too high. So we can go upstairs, go down our Bloomberg terminals and probably find 100 different explanations for why inflation is doing what it's doing and where it's going. But if we want to strip things down and try to make sense of this, what we can see is inflation is still too high. And an economist that we follow out at Stanford analogized this to trying to eradicate cockroaches. You don't want to stop when there's just two or three cockroaches left. You want to take care of the problem. So going forward, we're going to want to continue to see inflation coming down.

And unfortunately, that's not what we're seeing from market expectations. Look at the look at before the pandemic, markets expected inflation for the 5 years forward to be below 2%. So this is a calculation that we can pull from the market looking at the difference between index bond inflation, index bonds and nominal bonds. On the other hand, for the last few years, on average markets have expected inflation to be above 2%, running at about 2.5%. And what strikes me most about this line here is think back to when inflation was running like 7, 8, 9%. The market still expected that inflation would come down to about 2.5% for 5 years forward. Now we are much closer to 2% inflation. We just saw it's still too high, but we're a lot closer than we were. But the market actually expects inflation to be higher than 2.5% from here. Why could that be? It's probably because or potentially because there's not a lot of confidence that policy and economic conditions are conducive to dragging inflation all the way down to 2% where we want to see it.

Brent: Yeah. And what really strikes me is if you look at the far right-hand side of this graph, Blake, like literally from July of 2024, where we kind of dipped a little bit below the line and we thought things were normalizing as it relates to policy and we'd get to a better place, look at that big move up that we've seen in expectations, which is congruent to what you showed on the previous slide with that move up on that 3-month annualized, where they also started being at a low in July of 2024 at about 0.7% annualized, now sitting at 4.5% annualized. You know, so the market is moving in congruency to what that 3-month annualized inflation rate is looking like.

So, again, a lot of volatility where it ultimately settles and where we end up, time will certainly tell. I think it might feel safe to say that long-term inflation next 5 to 10 years is somewhere north of 2%. Whether that's 2.25, 2.5, time will certainly tell. But we are triangulating something above 2%, which is, again, sort of where the Fed ultimately would like to will it to be.

Blake: And with all as complex as it is, this is something that we feel like we can actually make sense of. We don't know where things are going month to month, but we can take a step back, look at these broader trends and take away that conclusion that you mentioned.

So what does this mean for Fed policy? What we're showing here, the dark blue line, is the actual Federal funds rate. And then the rest of this chart is what's the market projecting for months and a year or so forward. And it's important to remember that, as we saw in the very beginning on that first tile slide, the market used to expect several rate cuts this year. Now they're expecting fewer. This line has been changing substantially, but all we've seen so far in the last few months is a brief move downward by 100 basis points, a full percentage point lower in the funds rate and then the Fed has hit pause. And where we go from here is going to depend on economic conditions and inflation and how the Fed wants to react.

Brent: And boy, have the forecasts of where we're going to be at the end of this year varied significantly from as much as 10 to 11 cuts in this full cycle to sort of a low of almost 1.2 to 1.3 cuts. And now here we are at the end of this year, expecting a sort of terminal value of about 3.8%, which is a little bit more than two 25-basis-point cuts that we see between now and the end of the year. And there are some economists out there saying that the actual next move for the Fed might not be a cut at all. It might actually be a hike.

So broadly, it is a very interesting and mixed-view time. And certainly, at least our opinion is that the Fed will likely be data-dependent, but I think sort of the mosaic that we are setting up is that they're kind of on a knife's edge as it relates to the path forward because they're balancing what you talked about, which is accelerating inflation, right, and inflation that's still stubbornly above where they want it to be. And potentially what we'll cover in just a second is a labor market that might be facing some headwinds in the future. So balancing full employment and price stability is certainly going to be a challenge for them in the coming months.

Blake: Yeah, there's times when even when conditions aren't good, like when you can see when the Fed was hiking these rates in 2022 and 2023, that wasn't a particularly enjoyable time.

Brent: No, it wasn't.

Blake: But at least you knew with some kind of confidence, what's the next direction of these moves going to be? And what's uncomfortable right now is the amount of uncertainty. The Fed's on hold. It's not in a clear, a clear hiking or cutting cycle. So markets are being nimble around what these moves might be.

Brent: So let's shift gears and let's talk about that labor market, and what we're looking at here is a 3-month moving average of job creation. That gold line is the estimated break-even rate that we sort of need to be above, which is between 100,000 to 130,000 jobs per month to keep the U3 unemployment rate from moving higher. So in essence, as long as we're at or above that line, we should see unemployment broadly stay in check.

What you can see is, look at the right-hand side of this graph, right? We've seen an acceleration sort of from that, you know, the lows that we saw, you know, in the second half of 2024. Think about, you know, December, January, that 3-month moving averages actually moved up, and we saw some revisions to the data, right? So December payrolls got revised up to 307,000 jobs. We did see a soft print in January. Expecting 175,000 jobs, came in at 143,000. I expect that when we get the jobs data on February, or sorry, March 7, that that might see some type of revision. But when we look at the jobs data that is going to be coming next Friday on the 7th, the current expectations are about 155,000 jobs. We'll have to see what that actually looks like. But broadly, the labor market, again, this is all jobs, looks okay, and we'll have to see what it looks like going forward.

So a question that we've been getting an awful lot is what's going on with DOGE? What's going on with cuts within our government employment? And what I want to say, I think both of you want to say this, is that we are not here to opine whatsoever on whether this is good, bad or indifferent, whether this will be successful or not. We just want to sort of lay out the broader understanding of what we're dealing with here.

So what Blake and I thought we would do is just give you some high-level factual data, and let's start with the executive summary on the right over here and then we'll tie that into the picture. Right now today, when I look at all jobs in our economy, we have about 160 million people on US payrolls, which includes private sector, government, et cetera. So that's all people working. And you take that down, of that 160 million people, there are 3 million federal government employees, which represents approximately 2% of all US workers. Inside of that, right, if I take this a little bit further and we think about not only governmental workers but governmental contract workers, government contractors sit at about 7 million workers. So about combined together, 3 million federal government employees plus 7 million government contractors, it's about 10 million total workers, or about a little over 6% of the workforce.

So kind of putting into perspective sort of what the graph on the left is sort of highlighting, and when we think about, importantly, what are the total outlays for government workers' payroll, again, about $300 billion—which sounds like a lot—right, but remember, we have a $7 trillion-a-year fiscal budget and we are an almost $30 trillion total economy. So in the grand scheme of things, $300 billion, which for most normal mortals sounds like a big number, in the context of our government, that is not a big spend at all. Three hundred billion is only roughly about 4% of our fiscal budget outlays, so even if you were to triple that number or bring that up as it relates to what might be spent for government contractors, the overall number is effectively sub-$1 trillion, right? So let's just say that.

When we think about where we are today on the total estimates of job cuts right now within the within the overall DOGE initiatives, it's sitting at about a 100,000 workers so far right now—pure governmental workers. A vast majority of that, about 75,000, are sort of that voluntary, you know, retirement or termination. And we think from an estimate perspective, that total amount could rise as high when we sort of look at what some of the market prognosticators are saying that could rise to as high as about 500,000 workers. Again, 500,000 is not 10 million, right? One hundred thousand government workers isn't the 3 million governmental workers. So, at the margin, when you think about what that might initially cut out of the total budget, it's a small amount.

And in this and the next slide is something that Phil and I have talked about on a lot of our webinars is, let's talk about total governmental spending as a percent of GDP as I talked about. Our fiscal spend right in 2025 is projected to be about $7 trillion. So what we want to do is, again, break down what is actually discretionary. and what is nondiscretionary. So right now, in 2024, total discretionary spending is about 28%, which means 72% is sort of mandatory spending. So think Social Security, Medicare, Medicaid, et cetera. Within that 28%, Blake, that's discretionary, 15% of 28% is defense spending.

In the world that we're living in, which has become a more dangerous world where we're seeing escalations whether that's the Eurozone or Asia building up or talking about increasing their military spending as part of their broader economic spending in the future. So the amount that I could take a scalpel to as a percent of our actual budget is not that big. And again, just to be clear, anything that would potentially be done in mandatory spending requires a super majority, which is a 2/3 vote and a replacement plan. And if you think about how tight it is between Democrats and Republicans in either the House or the Senate, getting through a 2/3 supermajority to make changes to mandatory spending could prove challenging, which is why you're seeing a lot of executive unilateral orders here. So by and large, just wanted to kind of paint a broader mosaic of both what's going on with government workers as well as overall spending.

Blake: And of course, on the bottom, there is another layer that you can't cut out, which is how much we're paying on interest on our debt. That's part of what's crowding out some of the spending.

But let's take a step back and return to the employment picture and think about how might these changes affect the broader picture here. It's important to remember that we're still at close to generational lows in the unemployment rate. The unemployment rate bottomed out at 3.4% a year or two ago, and it has risen. And we didn't like seeing that move upward because look at the long history of this graph. When the unemployment rate tends to move up, it hasn't really stopped. It's resulted in a recession. That hasn't happened. The unemployment rate has actually started to move sideways over the last several months and is now at 4%.

Most people are projecting the next move of a few tenths is probably higher than lower. So we're going to be back to this world of seeing is it possible for it to move up modestly and then just cool down. And from an economic perspective, one of the biggest reasons why this matters in supporting our economy is that 2/3, 70% of the economy, is consumer spending. And with so much uncertainty out there around what's going to happen with job cuts, what's going to happen with investment in a highly uncertain time, the businesses might not be as willing to take on a big new project. Or what's going on with international trade, that's another component GDP with tariffs, that might be another area where things slow down. But as we can see on this slide here what has worked well and what has for years been underlying the strength of the economy is consumer spending.

Brent: Yeah, so let's go to the next slide, Amy.

Blake: But is that going to continue? What we've seen from our analysis is that consumer spending, as we see on the next slide has not been coming from a particularly broad base. Consumer spending has been driven by the highest-income earners, and frankly that's kind of always the case. Most of the income coming out, most of the income in is among the highest-earning households.

But unusually, what we've seen here, since 2021, 2022, the lower quintiles of consumers have not seen any real inflation-adjusted spending growth. So this helps me make a lot of sense about what's going on out there in the world. Why are we getting such low responses on consumer sentiment surveys and consumer confidence surveys, despite the headline aggregate strong statistics that we started off with. And when we're thinking about the forward look on the on the economy, what's going to happen with consumer spending, for better or for worse, we do care most about just where's the bulk of that spending happening? But it is really important to think about what's happening underneath the frame and how broad-based is this spending.

So this is just another reason why on the headline, we like the aggregate number, but as we look in and get into the details, sometimes these things aren't quite as strong as they seem to feel.

Brent: Yeah, completely agree. And we're going to have to monitor the situation as we move forward.

So let's shift gears, Blake, and let's talk about the markets, which is squarely on everyone's mind. And then we'll jump right in, Amy, and again, one of the questions that I think, Blake, we get maybe six times a day, seven times a day from clients is, "It's been fantastic. You guys have talked about this bull market run and how much we're up. I'm really concerned about where we potentially go from here."

So let's talk about this current bull market, which started back in the middle of October of 2022. So we're going on about 28 months of this bull market. Total cumulative returns for this bull market since October 13th of 2022 through this week on the 24th were up 69% cumulatively. And the question that I'm getting was, "Well, Brent, how much longer, and how much higher?"

So in order to do that, I think what would be easiest is just to try and give a little bit of factual history on bull markets. So if I go back the last hundred years or close to the last hundred years, starting from 1926 to now, we've had 11 bull markets. Seven have occurred post-World War 2. The average length of a bull market has been a whopping 6.6 years in length, with a total cumulative return of 339%. Post-World War 2, that average has gone up to 9.3 years in length and 466% cumulative return. And when I look post-World War 2, the shortest bull market was 2.5 years, right, so a little bit longer than where we are right now and a 76% cumulative return.

So as the old adage goes, bull markets don't die of old age. They usually get murdered. And as it relates to potentially what happened, just because equity markets have run for a longer period of time does not mean that they can't run further. And as Phil and I and you have talked about time and time again, and we'll get into a little bit, the fundamental side of the equation for equities remains strong. We'll talk about corporate earnings and profitability and revenue growth and what that earnings trajectory actually looks like. And certainly valuations at this stage are a little bit challenged relative to history and relative to what we've seen, especially on a forward-looking basis. But that does not necessarily mean in and of itself that a bull market is close to an end. We've been here many, many times before.

So on the next slide, Amy, let's talk about where we are year to date. Let's look at the panel on the left. Let's look at what we've done so far to date through February 24th. US equities is represented by the Russell 3,000, which includes large-cap, mid-cap and small-cap stocks within the US, is up about 1.7%. Certainly early, right? Certainly not the 24% that we saw last year. But what is interesting is we started to see not only a broadening out, but we started to see other areas within the world doing well. So look at developed international equities up 8.3% year to date, up, geez, more than 6% better than US equities. Emerging market equities up 5.8%, doing better so far than US equities. And right now, interestingly enough, to date, US taxable bonds, the US aggregate fixed income, is basically tied with US equities at almost 1.6% and municipal bonds up 1%. So by and large, a broadening out in US equity markets beyond just US equities, which from an overall perspective is definitely good to see.

On the right-hand chart, what specifically within US equities is doing well? It's really two things so far today. US large-cap value up almost 6% and mid cap across the board up almost 2%, one and a half, 2%. By and large, small-cap negative year to date, whether that's value core growth. And the bellwether, think Mag Seven, US large cap growth, which has been the juggernaut in this bull market, is actually negative so far year to date. Again, we've seen a lot of vacillation within US equity markets, but certainly a different mosaic than what we've seen in the past.

Blake: And let's look at this bull market just over the last couple years. On the next slide in this dark blue line, that's just the S&P 500 index, and as you said it's marched higher and higher over the last 2 years. This dotted light blue line, is what fraction of the S&P 500 is currently at its 200-day moving average, above its 200-day moving average. And for the vast majority of this bull market, that fraction has been somewhere between 70 and 80-plus percent. So we like that. We like to see the vast majority of companies in the index performing very well, as opposed to just being dragged higher by maybe a few of the largest names.

That did deteriorate over the last few months and came down to the lowest share that we've seen in in over a year or so. And it has improved modestly but still not quite where we want it to be. So this is something that we follow closely when trying to think about, does this bull market still have legs. We want to see breadth. We want to see many companies doing well. And thinking about just the biggest companies, which we've all heard about, we know, as we see on the next slide, that they're expensive.

Brent: Yes, which is the gold line here.

Blake: The gold line, the top 10 equities in the S&P 500 are trading at a forward P/E ratio of close to 30. That's expensive compared to the last 25 years. The rest of the index, however, is trading at closer to its historic average. So there's two ways to see this. One is these top 10 equities are very expensive. The other way to look at this is that the other 490 companies in the index are trading pretty fairly. And we see that as a as potentially an opportunity.

Brent: Yeah. And certainly as we've been talking about much the last couple of webinars is that, you know, seeing that breadth continue to widen out would be a healthy sign for the equity markets to march higher.

I think what's important on the next slide, Amy, is let's look at the backdrop of the underlying fundamentals, right? We've talked about corporate earnings and profitability driving this bull market. And let's cover what's on the left here. As we get close to wrapping up 2024, you know, we're looking at earnings growth of almost 10% for fiscal 2024. What I think is most interesting is look at the fourth quarter, right? You know, as we get close to wrapping this up here, you’re looking at fourth quarter to date growing at 16.9% for the quarter. That is the most, if that holds, that would be the most significant quarterly growth since basically the fourth quarter of 2021. So you're looking at just incredible growth, you know, and we talked about on previous webinar that maybe we're getting to an end, that corporate earnings and profitability would be decelerating. And so far, that's not the case.

As we roll into this year, what are we estimated to see from a corporate earnings perspective? We're sitting at about 12.7%. Now, that has come down. We had been stuck between that high 14%, low 15%. But as analysts, as we had talked about, sharpen their pencil as it relates to earnings. You know, it's come down a little bit, but still significant double digits, almost 13%. And I know this is ridiculously early to be even talking about. We're barely into 2025. But look at the estimates for 2026, almost 14% earnings growth. If you look at this year and next year, compare that to the long-term average since 1950 of about 7.6%. You know, it's 1.5 to 2 times the long-term average. So again, corporate earnings continue to do well. Expectations for corporate earnings and profitability continue to look robust. And we think that that's going to continue to power this bull market.

Now, what I will say is certainly there's lofty expectations that have been baked into it, and companies have to hit these numbers for the market to continue to do well. So far, so good. And time will tell.

So let's move forward. And one of the things that we're looking at is what could potentially drive or continue to drive the top end, you know, that top 10% or 10 names within the S&P 500. Think that Magnificent Seven. One of the things that it's been very interesting is what is big tech spending as it relates to future investment? And we think about CapEx, or capital expenditures, for these big-tech companies. If you look at the projection of the dollars that the Mag Seven are looking to put into the ground, which again, you put money into projects, you put money into capital expenditures, for a thoughtful future return on investment. Look at the investment that these companies are making to drive the potential for future growth. It's expected to accelerate. Companies that might not have the most rosy picture or forecast going forward don't put that percentage of into capital expenditures to drive that future growth. So again, the Magnificent Seven, great financial companies doing pretty well and expected to continue to spend.

Blake: On the other side of things, as we have been saying multiple times, some kind of a cloud overhanging all this is this uncertainty picture. And one of the biggest drivers of this is what's happening on the international trade outlook. So what we're showing here is what tariffs look like over the long history of the United States. And for the last several decades, tariffs have not really been a big factor. Even over the last few years before the pandemic, when the tariff rate rose, compared to just several decades before it was still quite small. That's changing now. The range of possibilities for what's been proposed from the White House is the steepest tariffs in over 100 years. The question that markets and investors are asking is how much of this is real. And this is why we're framing this more in a context of elevated uncertainty than necessarily of extreme risk. And we are following this day to day. And I think the trend that's coming out is, compared to a few months ago, these risks do seem a little bit more real compared to what markets thought maybe was going to be the case. But this is a huge layer of uncertainty hanging over markets.

What are tariffs? Tariffs are a tax that is imposed on a person or the company importing something from a foreign country. And then how does that affect profit margins in the economy? That depends on what happens with that additional tax. Is it going to get passed through to prices? Is it going to weigh on profit margins? Is it going to affect growth? Is it going to affect imports?

So something that we are approaching this with is a huge amount of humility. And we've seen forecasts and we've seen models that are saying, this is the effect from these tariffs. And we will very much consider the range of these outcomes. But we have heard people argue that these tariffs are going to be extremely inflationary. Some of the analysts and the economists that we pay attention to said it's not quite that simple. They could have an effect on growth, and the effect on prices is not clear at all. The one thing, again, that we are pretty confident in is that this is a layer of uncertainty weighing over the economy. And as we think about what you just said about CapEx and investment, this is something that companies are going to be worried about.

Brent: Yeah, it's certainly a give and take, right? It's harder to continue to put money into expensive projects when the future is uncertain.

So let's transition and let's talk, and we're going to hit this relatively quickly because we talk about in our webinars, we really want to hit these really on a quarterly basis, but we wanted to remind everybody what our next 12-month price target is for stocks. And you can see here base case, you know, 6,400, which you can see from February 25th, is about 7% higher for the market. Bear case here, 4,600, which is about 23% down. Bull case, again, about 15% up from where we are today. You can see a little bit skewed to the downside. But again, as we've talked about in the past, you know, our base case is looking at a little bit more of a haircut to corporate earnings and profitability over the next 12 months. And relatively flattish multiple here. By and large, certainly time will tell, and we're going to hit this pretty significantly next month, as it relates to where we go from here.

So on the next slide, I think one of the questions that we get quite often, Blake, is, "Ooh, okay, well, the market's been selling off last handful of days. I think we're down a whopping like 2-ish percent the last couple days. Should I be worried? Should I be thinking about? What is normal?" So what you're looking at here is the last, geez, 30-plus years of calendar S&P 500 returns. So the dark blue bar is the return for that calendar year. The gold diamond here is the intrayear drawdown.

So let's, you know, take a look at an example here. When, when you kind of look at 2020, which is sort of my favorite year, right? So from February 19th to March 23rd, the S&P drew down 34%. We ended the year positive 18.4%. So on average, the S&P an entry-year drawdown of about 15%, right? Despite that 75% of the time, the year ends positive. So intrayear drawdowns and volatility intrayear are beyond normal and have occurred, as you can see up here, virtually all the time—some smaller, some larger—but more often than not, the equity market ends up positive. So please do not let short-term volatility dissuade you from your financial goals and objectives and how you specifically invest. So just kind of make sure that you're staying on that plan.

So on the next slide is another question that we are getting a lot right now. You know, "Brent, Phil, Blake, I have cash sitting on the sidelines or money that I'm going to be getting from maybe a bonus, and you know, when should I be putting it into the market?" So this is a slide that we had done a little while ago. And when it's looking at it, it's the period of 1980 through the end of 2023. So you're looking at, you know, 43 years' worth of data here. And it said, okay, if I were to put $12,000 a year into the market for 43 years—so you're talking about a little over $500,000 of total contribution—let's walk through some scenarios. The bar on the far left is, if you had perfect timing every single year for 43 years, you could magically put that $12,000 into the market at the market low, right, which is an impossible feat, virtually impossible feat, what would that actually grow to? So that $5,000-ish would grow to over $10.5 million. So that is the epitome of perfect timing, which is something that most mortals can't ever do.

So let's look at other scenarios that you might consider other than perfect timing. So let's pretend you had the absolute worst time, which sometimes a lot of investors and clients tell me that they have. You're actually putting that $12,000 a year for 43 years at the market high each year for 43 years, which is almost as impossible as perfect timing. You can't get it wrong every single year for 43 years. Very, very low probability. You still captured 76% of perfect timing. As you continue to move, if I put that money, that $12,000 each year for 43 years on the first trading day of the year, you captured 92% of perfect timing. And then when you go to the last bar, what many clients do is thoughtfully invest that $12,000, $1,000 each month for that 43 years, you're capturing 87% of perfect timing.

The dark blue bar here is you think about this too much. You sit in cash. You don't get invested in the market, and you just sit there in cash for those 43 years of that $12,000. You're basically capturing only 5% of that $10.5 million. So again, at the end of the day, it doesn't really matter much whether you have the worst timing or you put all your money in on the first day of the year or you're dollar cost averaging. The most important takeaway here is to make sure that you're thoughtfully investing in the market over time and in congruency to your long-term plan. So don't overthink, am I putting my money in at the worst time, the wrong time? Being invested is what matters, not worrying about the actual market timing.

Blake: Let's flip gears quickly and talk about fixed income for a few minutes. The takeaway here is that fixed income has been volatile for at least a couple of years. And we've even seen that just in the last 6 months. So what we're showing here is the full US Treasury yield curve. So all the way from the 1-month bill on the left, all the way out to the 30-year bond on the right. And I would suggest looking at two things here because there's a lot on this slide. First, what's the shape of these lines? And second, how low or high are they?

So let's start with where we are today. The gold line is the latest date. We have a 10-year Treasury yield at 4.3%. Where has that been over the last 6 months? On September 16th of last year, on the eve of the Fed cutting interest rates by 50 basis points, the 10-year yield was 3.6%. Just a few months later, it rose all the way to 4.8%. And that's where we were trading not that long ago in January. Things have moved down now over more worries about economic data, more uncertainty as we've talked about, and now we're down to 4.3%.

The second thing that I would suggest looking at is the shape of this curve. So the curve was inverted as recently as September. We had very high short rates and then the 5-, 10-, 30-year Treasury yields were even lower. That steepened in the later part of last year and into January, with the longer end of the curve higher. Where we are now is things have flattened. Look at how the 1-year is at 4.2, the 10-year is at 4.3 and the 30 year is at 4.6. That's a pretty flat curve. But the takeaway that we want to emphasize here is that there has been a lot of rates volatility. And as these yields have changed, that obviously feeds through into volatility in prices as well.

Brent: Yeah. And I think, you know, to me, the takeaway is as monetary policy continues to vacillate based on where inflation and the labor market goes, we're likely to see more volatility in the fixed-income markets. And I think ultimately, again, and we'll talk about this in a second, starting yield is a pretty nice predictor of future performance. And again, I would argue that even though that we have volatility in rates, we're certainly in a much better place than we were, let's say, back in August of 2020.

So, to that point, Amy, why don't we go to the next slide and let's talk a little bit about the Treasury yield.

Blake: Yeah, so speaking of that starting point and this volatility, we looked at the last 6 or 7 years and thought about, what has happened? What have we lived through? To be clear, the 10-year Treasury yield is very rarely flat and smooth. But we did look at historic volatility, and it has been quite elevated over the last few years. And we pulled some examples here just to remind us of things that have happened just since 2020. Look at the bottom there in 2020. The 10-year yield hit a low of 0.5%.

Brent: Crazy.

Blake: And shot all the way up to the fours, scratched 5% at one point. We've had banking stress. We've had changes in inflation. We've had growth scares. And the market is always going to be delivering uncertainties to us. But it is important to note that these last few years have been abnormal in just how much we've lived through.

Brent: And likely to see more, and certainly understanding, right, when I kind of look at the 2020 lows all the way up to the highs in 2023. As yields rise, bond prices fall. So investors' expectations of like, wow, it really hasn't been a great environment for fixed income is a manifestation of that post-pandemic environment and the impact of that as it relates to fiscal and monetary policy stimulus and what's going on with rates. So again, understanding where we are today and what that means from an investor's perspective going forward is what matters most, not necessarily where we've been.

And to that point in the next slide, Amy, is we've covered this before, and I'm going to summarize this very simply, is that the starting yield for fixed income—and what we're quoting here is the yield to worse, which is nothing more than the yield to maturity of a bond adjusted for the callability and the optionality embedded in the bonds—is a great predictor of future returns over the duration horizon of the bond.

So what we're looking at here is the broad US aggregate bond index, and you can see that yield to worst here and what the actual total return forward over that duration. So you can see almost 93% of the time, right, the US aggregate bond index had a return in excess of its starting yield to worst in the more recent periods of time where that was below was a byproduct of what we've talked about earlier with the most significant monetary policy actions in 40 years and what's happened with the rise in fed funds. But by and large, investors have to ask themselves, "Okay, great. What is the cycle that's in front of me? Is that one of hiking or cutting? What is my starting value?" And right now, today, fixed income is sitting at a yield to worse of about 4.7%. So again, more often than not you've captured about 110% of that starting yield to worse. So again, we think that the floor to expect a return for fixed income from here for both taxable bonds and municipals looks decent.

So Amy, I can see we have an awful lot of questions. Why don't we jump to Q&A?

Amy: Yeah. Brent, Blake, thank you both so much for that. There's just a barrage of headlines these days, so it's really nice to have the two of you take a step back and walk through some of these items for folks. Before we jump into questions, just a reminder to everyone, if you're not already subscribed, we do release several publications throughout the month, and we would love to invite you to sign up to receive that information.

Let's jump into questions. Brent, they were a little bit hot this month. A lot of people are a little bit concerned about what's going on. So just right off the bat, how do you plan and invest for the long term when there are policy changes every 4 years—sometimes drastic?

Brent: Yeah, I think what is amazing is if you think about over the last 150 years, the changes that we've had back and forth between political parties, all the things that have occurred in our wonderful country, right? Against that backdrop, the equity market time and time again has thoughtfully moved higher. I'm not saying it's without volatility, but at the end of the day we have to make sure that we divorce—whether it's geopolitical headlines, wars, pandemics, politics—from the underlying fundamentals of businesses and the ability for equities to move higher.

And at the end of the day, we think the financial side of things and the fundamental side of things trump everything else, no pun intended there, Amy. But by and large, you have to think to yourself, how do I make sure I'm not my own worst enemy? And what we espouse all the time is that we believe clients should engage in financial planning with us to make sure that you can kind of shield yourself from all the noise and all the things that can come crashing into you that would make you do things that aren't constructive to the long-term accretion of your wealth.

Having a comprehensive financial plan, identifying your goals and objectives, and understanding what rate of return you need to achieve to see all your goals and dreams through to fruition is really what investors should do to shield themselves from all the noise because it's not going to stop. And it might start sinking into your mind and thinking, well, geez, I don't really like where the country is going, or I really like where the country is going. And depending on what side you're on, that can sometimes infiltrate that investment decision-making, and you need to shield yourself with financial planning, Amy. So again, look at what the market's done through the last 150 years, despite all the political changes that we've seen in this country. And again, the US stock market has triumphed.

Blake: I would follow up with that with admitting it. Yes, there's a lot that's gone on the last 4 years. There's a lot going on today. I challenge us to find a 4-year period where there hasn't been a lot that's been going on. And politics and policies are absolutely an important factor, but they're only one factor.

Brent: That's right. That's right.

Amy: On that same topic, DOGE, tariffs, tax policy, there were a ton of questions around the short- and long-term implications with that uncertainty. And it's certainly something we talked about during the presentation, but just want to re-emphasize.

Brent: Yeah. Yeah. So look, I think Blake said it best. There's just an awful lot of uncertainty. I would argue there's a lot coming at us. We're going to have to wait for the facts and the detail to settle down. I think at the end of the day, putting it into perspective is that no one would debate that we have a large debt burden in this country. We have a pretty significant fiscal deficit, right? We are going to spend, or it's the CBO is projecting that we spend $7 trillion this year, right? The total net revenues that we have to offset that $7 trillion is only 72% of that. So we're about almost 27 to 28% in the hole just for this year, so running a deficit.

So does anyone debate that we should be looking at spending and what we're trying to do to make sure that we're not recklessly spending or spending on things that we shouldn't? Absolutely. I think both parties would agree to that. Thank you, Amy, for putting this up. What I would argue is it's kind of hard to find where you can really cut the fat when only 28% of that $7 trillion of fiscal spending is discretionary, right? And of that, a significant majority of that, more than a half, is defense spending. So it's going to be hard for DOGE. It's going to be hard for the current administration to really find a lot that's going to make a monumental difference. And ultimately, a goal with things that they want to think about as far as passing, whether that's the Tax Cuts and Jobs Act and other things that they want to do and legislate on. Time will tell where we end up, but I think we just kind of have to wait and see, Amy, to really see where DOGE and this government ends up.

Blake: I think this is a good opportunity to clarify a little bit by, what do we mean when we say this word uncertainty that we've been layering throughout this presentation? To be clear, that's not just a fancy way of saying "I don't know." Uncertainty affects households. It affects businesses. It affects investors. And in an uncertain environment, that's a time when people might not be willing to take risks. It's a time when people might not want to take a leap and start or expand a new business. It might be a time when people are going to pull back on an expansion or on imports if we're talking about tariffs. So this makes its way through into business confidence, into consumer confidence, and all of those things make their way downstream through the macro system. So there's never perfect certainty. There's never anything close to it. We all crave it. But in times of elevated uncertainty, which we can point to, it can have a significant downstream effect.

Brent: Yeah. And look, that's what we're here for, Amy. In an environment where we have this degree of uncertainty, please, our clients should lean on us to help them think through their goals and objectives, think through their investment policy. And I would argue, and if you think about what the legendary Jack Bogle, the founder of Vanguard, said, he said one of the greatest advice that I could ever give an investor is staying the course. Don't let these externalities and internalities affect your strategic roadmap and course forward. And I would espouse those same things. Lean on us to help get you through these times.

Amy: And not to belabor the point, but there were several questions around government job cuts and how that may impact the employment rate and effectively into interest rates as part of the Fed's dual mandate. Can you speak to that, please?

Blake: Sure. To reiterate, we need to think about the direct effect and the indirect effect. So the direct effect so far is probably about 100,000, that's the best estimate that we've seen. That could rise in the short term if we also count contractors, to about 250,000. Those numbers sound pretty similar to me to roughly the amount of jobs that come in each month in the nonfarm payroll support. So that's one way to think about it. A significant chunk, but not a huge share in terms of the whole economy.

But with kinds of shocks like these, we always need to think about how does it affect the next layer and the layer after that. So government employees and government funding affects government contractors. Those government contractors might be a significant economic force in some areas of the country. There might be services employment that depends on some of these employees and some of these contracts. So when you push a button or you shock the system somewhat, it can be easy to see what are these first few numbers, these first few effects. But what we ultimately care about is how big of an effect is this going to have on the system.

Brent: Yeah. And again, I think we're going to really just have to wait, because remember, of that 100,000 estimated government lost, right, 75,000 of them took a package, right? So the underlying linear sequencing of them still getting paid for a period of time and the impact on spending, it's a very, very complicated Rubik's cube that we'll have to figure out. We're going to have to just let it play out a little bit to actually see what the underlying impact will be on the labor market and ultimately on consumer spending, which is a driver in the juggernaut of our economy.

Blake: Yeah, and lastly on this, something that we'll be paying attention to with the effect of these cuts is what's the so-called re-absorption rate? So if an employee is cut loose or decides to leave a government job, what's the likelihood that they're going to be gainfully employed in a similarly lucrative role?

Brent: In the private sector or whatnot.

Blake: Right. And we can look at that through labor demand, which as we've shown in many of the last several months, labor demand is still pretty decent. It's softened from where it was, but there still are a fair amount of job openings out there. So these are the kinds of things that we're keeping tabs on to try to estimate this effect.

Amy: Well, Blake, I think you put it really well when you said the theme of this webinar is uncertainty. So let's talk a little bit, let's end on a high note, let's talk about something that's positive and stable and just highlight that for everyone.

Brent: Positive and stable. Look, as we started this conversation, the broad pulse check of our economy today is quite solid, right? Corporate earnings and profitability have been in the best shape that they've been in in decades. So again, if God forbid, we were to get to a point where we start to slow down, we're starting from a very, very high point, which is a good thing. So I would argue, everything taken in totality has to be reconciled. It's very easy to myopically focus on, well, you know, government jobs or this or that. At the end of the day, what truly matters is the rollup of all those things, Amy, and I would argue, again, to end where we started, our broad economy is in good shape, and the underlying fundamentals of corporations are quite good today.

Blake: Yeah, one of our favorite things to say is that we like good news. Sometimes we've seen in recent months the market has reacted the other way, but we're always takers of good news.

Amy: Well, thank you both. Again, Blake, great job on this month's report. I just want to thank everyone for taking the time to listen and trusting us to bring you this information. That's something that we never take for granted, and we will be back with you again next month. Thanks, everyone. Thank you.

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Authors

Brent Ciliano CFA | SVP, Chief Investment Officer

Capital Management Group | First Citizens Bank

8510 Colonnade Center Drive | Raleigh, NC 27615

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

Phillip Neuhart | SVP, Director of Market & Economic Research

Capital Management Group | First Citizens Bank

8510 Colonnade Center Drive | Raleigh, NC 27615

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

Blake Taylor | VP, Market & Economic Research Analyst

Capital Management Group | First Citizens Bank

8510 Colonnade Center Drive | Raleigh, NC 27615

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

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