Making Sense: January Q&A

Amy: Hi, I'm Amy Thomas. I'm a strategist here at First Citizens Bank. Today is January 15th, 2025. I'm joined by our market and economic research team, Phil Neuhart and Blake Taylor, to talk about some of the questions we're hearing most often from clients.

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. This information should not be considered as tax, legal or investment advice.

So Phil, we just wrapped up 2024. It was a really surprising year based on analyst predictions. What are you seeing going into 2025?

Phil: Yeah, it's a fair question—what everyone is asking. 2024 we had 25% total return in the S&P 500, pretty remarkable return. Recently, we've had a very small drawdown, about 4% as of this moment. So the question is, you know, does that continue?

Our expectation coming into the year is the price target in the S&P 500 of 6,400. We expected an up year, but when we set that price target, it was only up, what, 5 or 6% from where we were trading, but the market did peak on December 6th, obviously, up more today.

When we set that price target, though, we did not think the market would move in a straight line. And we are seeing return to normality, which is a little bit of volatility, and we would not be surprised to see a decent amount of that this year.

Why is that? Several reasons. One, higher interest rates. We have seen—and we'll talk about it more in a moment—rates move higher in the Treasury yield curve. That, of course, is a challenge for equity markets.

Additionally, we have policy uncertainty—both on the fiscal and trade front and on the monetary policy front. Of course, a lot of Fed cut expectations have come out of futures markets, and we are seeing fewer expected cuts. And then also the market valuation is elevated. When you look at measures like price-to-forward-earnings, this is not a cheap market. That, of course, is a challenge for the market as well.

So we think fundamentals remain in place. A recent employment report, which we'll dig into more in a moment, is a reminder of that, and earnings expectations are solid. So it's not that fundamentals aren't in place. It's just that we're coming from a very elevated position with heightened uncertainty. So, yes, we remain cautiously optimistic, but are not surprised to see the market bounce around a bit—and would not be surprised to see much of that this year given the setup.

Amy: So, Blake, the Federal Reserve started cutting interest rates in September of last year, and since then, the Treasury market has done some interesting things. Will you talk about that a little bit?

Blake: Yeah, this is one of the most interesting dynamics going on right now. The Federal Reserve has cut interest rates by a full percentage point, yet the 10-year Treasury yield is up over 100 basis points. That's in the opposite direction than what history has shown us before and what many thought would have happened.

So what's going on there? Compared to when the Federal Reserve started cutting rates in September—with a 50 basis point larger size cut, initially—the economy is stronger, the labor market is healthier, and inflation is still very much a problem.

So that's a good example of what's going on on the longer end of the Treasury curve, like at the 10-year and things that affect the 30-year mortgage rate. Those depend very much more on expectations for growth and inflation and treasury dynamics compared to at the short end of the curve, that's where the Federal Reserve directly affects outcomes.

So the other way to think about this is how do we compare this to the past?Previous times when the Federal Reserve has cut interest rates and we've seen both the overnight funds rate, the 2-year Treasury and longer out at the 10-year and beyond come down, that's typically been when the Federal Reserve is cutting rates because we're entering a recession or the economy is very much weakening.

That's what we saw in 2020 with a global pandemic, 2007 with a global financial crisis, 2001 with the bursting of the dot com bubble and 9/11—and then significant recessions in 1981 and then a recession in 1989. What we've seen this time is the Federal Reserve coming out to preemptively slow the economy. That's more of based on expectations and a forecast and sometimes a guess of what's going to happen in the future for the economy. That worked out well in the 1990s a couple times when the Federal Reserve was able to anticipate potential weakness and lower interest rates.

So that's what we were trying to replicate in 2024 and into 2025. And what needs to happen for that to work well is for inflation to come down. So lastly, as we think forward, this is what gets back to how the Federal Reserve conducts monetary policy. They have a so-called dual mandate. They want to have maximum employment, and they want to have inflation at 2%.

Right now, we do have a very solid labor market, and that was made clearer in Friday's employment report last week. There's been a lot of concern about the labor market over the last several months, and what that report showed us is that the labor market's much healthier. Hiring is still going on, and there's less unemployment than we thought.

So that removes a lot of the risk that the Federal Reserve thought of why they might need to be making a lot of accommodation for the economy through monetary policy.

Second, inflation. Is it at 2%? It's not. Is it getting closer to 2%? It used to be, and it's kind of leveling off somewhere closer to maybe 3%. And that's bad news for a Federal Reserve that has to really kind of thread the needle well in order to continue with this campaign of monetary easing.

Amy: So, Phil, we're in the middle of January already. It's hard to believe. We're kicking off earnings season. What are some things you'll be watching?

Phil: Yeah, so fourth quarter earnings season is kicking off, really, as we speak. Expectations for year-on-year earnings growth are 11.7%, which is really good. Anything into double digits is strong earnings growth for the fourth quarter. Looking at 2025, expectations are still near 15%—around 14.8%.

So what will we be watching, given really lofty expectations is, of course, results always matter. Early results have been good from some large financial institutions, but we are very, very, very early in this earnings season. So, one, we want to hear what results are, but additionally—what is forward guidance? What are management teams saying in terms of 2025? What are they saying on the employment front, for example, in terms of hiring? Are we starting to see any cracks there in the labor market that to this point has just looked like it's normalizing? And what are we seeing on the demand side?

What are they saying in terms of trade implications there? And then for large tech companies, which are very important to the overall market, what is the plan in terms of AI investment and potential for AI, or artificial intelligence, revenue? That is something that's really going to be a focus this earnings season.

So we look forward to it. Earnings seasons are exciting to us because we get to hear at the ground level what is happening versus just macro data that we spend so much time between earnings season studying.

But it is—all earnings seasons are important—this one does feel particularly important given changes in the administration and changes in monetary policy expectations. What are management teams saying, not just the results they're reporting?

Amy: Phil, Blake, thank you so much for answering questions. We hope you found this information helpful. For more information, please visit FirstCitizens.com/MarketOutlook.

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Authors

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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