Making Sense: August Market Update

Amy: Hello, everyone. Welcome to the First Citizen's Wealth Management Webinar Series, Making Sense, where Chief Investment Officer Brent Ciliano and Director of Market and Economic Research Phil Neuhart help you make sense of what's going on in the markets and the economy. I'm Amy Thomas, a Strategist here for First Citizens Bank. And while everyone's logging in, I'll walk through a couple of housekeeping items with you. First, today's webinar is being recorded, and a replay will automatically be sent to you following today's conference. Secondly, this webinar is interactive. If you'd like to submit a question, please use the Q&A or chat feature on the right-hand side of your screen. All questions are confidential and only visible to myself and the panelists. I do want to remind you that we try to keep our discussion broad so if you have a specific question about your financial plan or we are not able to answer your question on today's webinar, please reach out to your First Citizens partner. As a reminder, the information you're about to hear are the views and opinions of First Citizens Bank and should be considered for educational purposes only. Brent, with that, we're ready to go, so I'll turn it over to you.

Brent: Great well, thank you, Amy and good afternoon, everybody. I hope all of you are well and Phil, it's hard to believe that this is the last week of summer. What an eventful and volatile summer it's really been. For that, there's a number of things that Phil and I want to jump right into. So, Amy, if we can go to the table of contents. So what are we going to cover today? So from an economic perspective, we're really going to triangulate on three areas today. We're going to talk about the labor market, the US consumer, the strength and resiliency there. We're also going to talk about corporate earnings and profitability. There's been a lot of chatter in the financial news media about corporate earnings and profitability. Will it be resilient? Will it stick? So we're going to talk about that. Then we’re going to talk about inflation, inflation, inflation, level, moderation. How high can it go? Have we peaked? Where do we go from there? From an expectations perspective, then we're going to go over to the market side, and we've got some interesting historical examples that we want to show. The first, we're going to start a little bit differently. We're going to talk about fixed income markets. Obviously, with yields, higher bond prices have gone down. So we're going to talk about the state of the fixed income market. We're going to talk a little bit about this rally. But we bottomed out on June 16th of this year, and we went it for about two months and it's starting to come back down. Will this stick? We're going to also then talk about what might be some price levels underneath where we are right now, where we could potentially see the S&P 500 going to and then the last two bullets here, Phil, we really want to talk about five reasons why you might want to remain invested. And we're kind of going to go through that over the short, intermediate and longer term. And then we're going to look ahead and look at returns over the next decade and what that might look like. So, Amy, why don't we jump in, and we'll talk about the economy.

So first, one of the resounding pillars of our economy has been the labor market, Phil. We saw in July, an incredible jobs number, 528,000 new jobs. The last six months running, we've been about 465,000 jobs. And we have a non-pharm payroll number coming out on Friday. Current consensus expectations is calling for about 300,000. So we're going to see if we continue to see resiliency in the labor market. We have to remember that we only need to put into context about 100,000 jobs-ish a month to keep the unemployment rate from moving up. So even if we come in a little bit shy of that $300,000 or come in out of the number lower understanding that the labor market is still strong, and the unemployment rate will likely continue to stay low. It is interesting, though, that when we looked at the Fannie Mae consumer purchase index sentiment, reading that we saw, one in four households are now concerned about losing their jobs. So we're going to have to really see whether or not we continue to have that resiliency in the labor market. So when we think about, you know, the important part of the labor market and the consumer, on the next slide, Amy, is we think about wages, right? An average hourly earnings, and it's been remarkably strong. In July, we saw 5.2% year over year wage growth. That compared to the 15-year average Phil of about 2.9%, you're looking at almost 80% higher. Obviously, when we bring in the ravages of inflation, we're still looking at a negative wage growth number. But could you imagine, Phil, if we were at that long term average where we might be? We talked about this a little bit on the last WebEx. You know, as gas prices have gone up, as food has gone up, as inflation has reared its ugly head, consumers have been shifting from savings to spending on credit cards and outstanding debt. And on the right, you can see that we hit credit card outstanding at one of the highest levels in decades. The good news is, as you'll talk about, as inflation has started to moderate a little bit, gas prices have come down a little bit. Food prices have come down a little bit. Spending on credit cards and outstandings have come down a bit, which is good to see, but we're still at significantly elevated levels. When we talk about gasoline and inflation and the ravages of inflation, when we get to the next slide, Amy, and we think about where we are from a sentiment perspective.

We talked about this, Phil, on the last WebEx. Consumer sentiment from the University of Michigan's Consumer Sentiment Index hit the lowest level ever recorded at 55.1. The good news is, in August, it ticked up a little bit to about 58.2, but the reasons were cited for the decrease in sentiment broadly, were the things that we’re normally used to, high inflation, global supply chain issues, discord in Washington. And while we're seeing it a little bit better, we still have a long way to go. When you look at the right chart and we look at the ever-important consumption, remember about 69% of US real GDP is consumption. The gold line is goods spending, the gray line is services spending. And you can see at 9.2% and 7.1% respectively, we're still well above Phil, the 20-year average. And it is interesting to see goods spending came down a little bit. But it's ticked up a little bit. Still a long way to go, but we're still hanging in there from a spending perspective. So one of the things that's gotten a lot of media play is that the ravages of inflation, the cost to businesses is starting to bite and eat into corporate earnings and profitability. So what we wanted to cover is what are the expectations for this year as well as the expectations for 2023? And now, Phil, you're going to get into this in a lot more detail when we get to the market section. But when we look at earnings expectations for 2022, sitting at about 8.6%, that's come down a little bit from the roughly 10% that we saw back in May and June. Interestingly enough, when we did our WebEx back in January and February, 8.6% was the expectation when we came into the year. So we went up and we've kind of come all the way back to expectations at the beginning of the year. Where we've seen probably the biggest haircut in expectations from analysts as it relates to earnings is really for fiscal 2023. That's come down from about 10% down to 6.8% so analysts are seeing sort of the biggest hit to earnings, not necessarily this year, but in fiscal 23. Both of them, though, compared to the long-term average of 7.6, is all in kind of shouting distance.

Phil: Right. So those are positives. Let's turn to what the market is so worried about, which is inflation. So here we're showing Consumer Price Index. Obviously, we're at 40-year highs. CPI, like we said, a little tick down, tick down from 9.1% to 8.5% in the most recent reading. But when you think about the market and the economy right now it is a very macro driven market. Think about the summer, market trades on inflation numbers, on Fed statements last Friday as an example. So this is what the market's really focused on. We want to spend some time digging into it. So where might inflation go, if we turn to the next page. First, on the left side, this is where we've been. This is year on year consumer price index in gray, you can see this is quarterly numbers so Q2 at 8.7%. Remember the Fed's target?

Brent: It's unbelievable.

Phil: The Fed's target is 2% so we are in a different realm in terms of inflation. Consensus estimates are on the right side, the gold bars. You can see consensus expects inflation to come down but remain unacceptably high end of this year at 7.3%. And additionally, something we add to this chart is to show just how wrong consensus has been. The black diamonds here are the March of this year estimate. So just five months ago, consensus had the end of this year at 4.5% inflation.

Brent: Right.

Phil: So you can see those gold bars are well above the black diamonds. And that's because consensus, the Fed and markets have all underestimated inflation. And to that point, we have a really active Fed. Chairman Powell spoke last Friday at Jackson Hole and reiterated that the Fed has not pivoted. The Fed's still hiking rates as a reminder to markets, even though we sort of felt markets should have already understood that the current target rate for the Fed funds rate is a range of 225 to 250 basis points, or 2.25% to 2.5%. Here we're showing what's the probability of various Fed funds rates at the end of the year, and the odds on probability is 3.75 to 4%, right? So we're talking about hundreds—

Brent: Significant.

Phil: 150 basis points higher than where we are today. Right now, the market is pricing 75 basis points in the Fed's September meeting later next month. So we have an active Fed and that is what is really driving the market right now.

Brent: Yeah and some of the language that came out of the discussion from Jay Powell at Jackson Hole is the potential for the Fed to keep rates higher for longer, depending on whether or not we see that moderation in inflation. So it's not just the level, it's also how long we might stay at that rate.

Phil: Right, and then there's really two things to think about here. One, the consumer. High inflation, even if it's lower than where we are today, is very painful for the consumer. And as we can see here, the consumer is in for a long ride, and we'll talk about that more in a moment. For markets, it's probably the direction. The market wants to see inflation start to trend lower. Right now we have one data point, one month of CPI, one month does not make a trend. So it is going to be the trend that really has markets focus. So let's dig into the components of CPI on the next page. On the left side here, this is pre-pandemic. So December 2019, inflation was 2.3%. What made up that low inflation? Shelter was half of it. Energy and food were roughly 10% each, motor vehicles and parts were a very little sliver below the line. There was actually deflationary.

Brent: Exactly.

Phil: But low numbers and about half was shelter. What we have now is 8.5% inflation. And a lot of these swing factors like energy and food have grown in proportion. So you think about energy, you think about gas prices, think about utility bills. Right now, one in six American homes are behind on their utility bills, right? So energy, natural gas prices, for example, would come into there. So if we flip ahead, what are what are we seeing in some of these energy prices? So here, this is retail gasoline prices down 23% from the high. That's good news. That is bringing headline inflation down. Something we're worried about is natural gas prices. The first month contract's up 66% the last few months in the US and worse in Europe.

Brent: I was just going to say outside of Europe they've got bigger issues.

Phil: Much worse there, but still bad here and winter is coming. So when we see natural gas prices on the rise leading into winter, that is problematic. So some of this positive from retail gas prices falling could be offset by natural gas prices, but the gasoline front is good news in terms of inflation. So let's talk about a couple of other factors that might be good from an inflationary perspective. One, global supply chains, right? This is an index from the Fed that measures pressure on the supply chains, right? It looks at everything from freight costs, think air freight, shipping, rail, backlog of orders, delivery times. So what you can see here, of course, is above 0 means high pressure. And we had a record level of pressure on supply chains earlier this year, late last year. That has improved. Now, it still is a problem. You can see this is still a very high level of pressure on supply chain. We're hearing that from clients, but you're also hearing from clients depending on which industry. But for many clients, things are still a little better than they were, say, three months ago or six months ago.

Brent: Absolutely, so it's not necessarily the level, it's the directional vector. And understanding as you look to that time series, it's never a straight line down. We're never going to get right back down to it. That's going to be jagged on the way down, but at least it's positive from what we've seen.

Phil: That's right. And this could be good news for inflation as we look forward. Another item that is slowing and we're watching very carefully is the housing market. So we've talked about this a lot and there was a lot of froth in the housing market. It was a pretty easy call that was going to slow down, and it is doing so. So if you look at homebuilder sentiment, what are builders saying? These are people on the ground. They're worried. Home builder sentiment has fallen. They are citing, of course, things like labor shortages, prices paid, the cost of doing business, but additionally demand, and that is what's changing in recent months is that demand, as you can see on the right side, existing home sales, is falling. It's similar if you look at new home sales. Housing starts just this week, Case-Shiller home price index came out and the level of appreciation is slowing in home prices. This makes sense. Mortgage rates are up. Home price affordability really fell and we're starting to see the pace slow.

Brent: Yeah and I think the big takeaway is, and you've said this on the last Webex, you know, the froth is coming out of the market, maybe a little bit more of the froth than we originally expected. But we're not looking at a great financial crisis type implosion in the housing market where we see an incredible roundtrip. We do see some moderation in home prices, but not something that's cataclysmic.

Phil: That's right. And housing is always regional. It really depends where you sit. But nationally, we are absolutely seeing a slowdown. So if we flip ahead, we won't dwell too long. We outline this slide every time we meet. Are we going to recession or not? So, so, our view is that the US economy is certainly slowing. We've just talked about that ad nauseam. Inflationary pressures remain high. We do not think we’re in an official recession first half of the year, even though GDP fell two consecutive quarters, because of things like real final sales, gross national income. We did see we see growth there and the labor market as we discussed. But when you look forward the next 12 months, we still think it's 50% chance of recession, a material risk. The economy is slowing. There's no hiding behind that. The question is, is this a mid-cycle slowdown or a recession?

Brent: Yeah and the economic data, as you nicely highlighted, is very mixed and highly variable. But as we said multiple times, if in fact, we do enter a recession, because of the underlying strength of consumer balance sheets, wages, etc., and a still robust labor market as well as record corporate earnings. And again, even though earnings and profitability is starting to moderate, balance sheets are still incredibly strong. We believe for those reasons that if we do have a recession, it would be short and shallow relative to a deep and protracted. So why don't we transition? Let's talk about what much, many of you care about is where do markets actually go from here? And again, Phil, we're going to start off on the fixed income side and it has been an unkind year for fixed income so far. Year to date, we are looking at, so far, the worst year ever for the Bloomberg US Treasury index, for US aggregate bonds. As you can see on that top right graph, a -10%, so far the worst ever for US aggregate bonds going back to the data series across the board. So it has been painful, yields up, prices down. But let's talk about some of the silver linings, Phil. Let's look at the first columns in each one of these graphics. And what we can see is, look at where the yields are versus where they were six or seven months ago, even a couple of weeks ago. Yields are significantly higher. So when we think about what that portends for future expected returns, a vast majority of fixed income forward expected returns are manifested in their spot yields. So as we have higher yields across the board, that does portend better expected returns in the future for fixed income. On the next graphic, Phil had a really nice piece that you wrote up a week or so ago that talked about the compensation that investors are getting. So yield per unit of risk. And when we look at this graphic just to interpret it, the higher up you are on this graphic, the more compensation per unit of risk that you're getting. And conversely, the lower on this graphic, the lower compensation that you're getting. Right now today, investors have seen the highest level since 2018 as far as compensation per unit of duration or risk, and nearly double the long-term average. So investors today are, in fact, getting compensated for taking duration, which is a nice thing to see because we haven't seen it in a while.


Phil: It's one of the advantages of fixed income, right? Prices go down, yields go up and suddenly you receive some compensation. So let's turn to equities on the next slide. So the S&P 500’s up 16%% year to date, but it's been a pretty bumpy ride, right? We went down a lot of headway north of 23%. Recently, we had a 17% rally, as you could see here. We're down as of this morning, 7.4% from that—

Brent: From the August 15th high.

Phil: from that recent peak. So we're in a volatile time. We'll be talking more about why that volatility might persist. Look, you don't know you're in a new bull market till you're already well into it.

Brent: That's right.

Phil: There's a chance that lows are in. But let's say they are. Let's say inflation remains sticky. We do not see a downward trend and if we flip to the next page, where are areas of valuation support? So when we say valuation here, we're just looking at next 12 months price to earnings ratio. All the price to earnings ratio is what are you willing to pay for a dollar of earnings as you look forward. So recently bottomed at 16 times earnings. You can see we've 14 to 15 times recent lows if we were to fall back to those previous lows recently evaluation. You're talking about the S&P around 3,500, 14 times. That's around 30, 3,260, as you can see here. And that equates to about 12% to 18% down from today or roughly five or 11% down from the previous low. So below where we previously traded.

Brent: Right.

Phil: But not a shocking amount.

Brent: Yeah I was just going to say, we're not we're not looking at a great financial crisis situation or a technology bubble, et cetera.

Phil: That's right. And Brett, so the level of E in this price to earnings ratio, earnings, that also changes, right?

Brent: That’s right.

Phil: There's variables that change. So we turn to the next page. We know that earnings are coming down, earnings expectations. If we focus on 2023 here, the black dashed line, you can see that we've saw it fall pretty precipitously in recent months and then have leveled out as we got past earnings season. As we look next year, you would expect earnings to come down further, but that doesn't mean earnings don't beat once you're in the year.

Brent: Right.

Phil: That's what's happened this year with the round trip you discussed. It is normal for earnings estimates to come down, but you overlay a global economic slowdown and there's reason to think it'll be a little bit worse. So there's two variables here moving. We would not want to ignore that.

Brent: So why don't we talk about five reasons why we think you really need to remain invested? And the first one comes up an awful lot. And we got some in the Q&A before the WebEx started. The first reason that we want to cover, Phil, is midterm elections that are coming up and the political combinations that we might see post November. So when we look at the first slide here, I think we've talked about this. I think virtually almost every WebEx for the last couple of months. Top left graphic, in midterm election years, we've seen a heightened amount of volatility and more significant drawdowns in midterm election years than non-midterm election years. And we're seeing that come to roost this year alone. The average drawdowns is about 17%. Lo and behold, we're about 16% now. What you can see is post midterm elections, historically, you've seen very positive returns, on the bottom right, you can see is that in 100% of observations post 1950, the 12 months post midterm elections have been positive for the S&P 500. When you look at that bottom right hand chart, you can see some really big bars, but also some very low bars. But the moral to the story is that on average, you've seen about a 15.1% annualized return for the S&P 500.

Phil: And look, you're talking about a small sample size. It happens every four years. But there does seem to be something in the market about getting past the midterm election year, getting past some of that uncertainty of the midterm election and looking forward.

Brent: Yeah, and another question that we get on the next graphic that we get is, is where we're triangulating with all this political unrest and how people feel, will that affect markets? So on the top left-hand graphic, we are showing you 150 years of governmental constitution and what that actually looks like. When I look at the two consensus outcomes that are out there right now, we're looking at a Democratic Senate and a Republican house, right? The Republicans only need four seats to take the house. And right now they're expected consensus about between 35 to 45 seats that they might take and a Democratic president. That constitution, which is the number one consensus expectation, has actually yielded the highest returns for the S&P 500 of 13.6% The next consensus expectation, which is an all-Republican Congress and a Democratic president, has seen 8.4%. So the moral of the story is, Phil, that the markets love divided government. On the bottom right, when we look at another graphic, which is looking at the years of a presidential cycle, the third year of a newly elected president has seen the highest returns for the S&P 500 at 22.2%. Next year is the third year for President Biden's term newly elected president. So maybe, hopefully history will repeat itself. But again, the current expectations would portend potentially better returns if history is any guide, not worse.

Phil: Yeah, very interesting. So if we look to the second reason, so forward returns post sentiment lows are actually better than you might expect. So if you look at the previous sentiment lows and we discussed University of Michigan sentiment a moment ago, Brent did, and you look at on average, what is the market do when you hit those, when people are just feeling really bad about things. Right, and the truth is, 12 months after those lows, the market on average returns 25%.

Brent: Right.

Phil: So it's a counter.

Brent: I'll take it.

Phil: Yeah, it's a counter indicator, right? What people are feeling, at the nadir, is when you potentially should move in. What's interesting is 12 months past highs, it's only 4.1%. So people are feeling the best is when you should have some caution. So it is interesting, the sentiment might actually be a good indicator for us from a market perspective. Looking ahead, in terms of returns after a hiking cycle. So similarly, if we flip ahead now, look, the Fed's not done hiking. They're going to continue to hike potentially for a couple more quarters even. But what is interesting is after the last Fed hike, you look at the next six months, you do tend to see the market recover. We get past this kind of getting past the midterm election and we know that, we don't know, but certainly there's a chance that the Fed's done hiking the next couple of quarters, a reason to look long term, look through some of the noise and expect better markets ahead.

Brent: Yeah, absolutely. And I think this fourth reason is one that we've covered on many WebEx’s. And when we go to the graphic here, Amy, and what we're looking at here, I know that there's a lot of data here, but what we're looking at here is every greater than 10% draw down post World War II. Lots of things going on, lots of events, lots of different types of bear markets, event driven, cyclical, structural. And I really want the listeners to focus on only two columns. The third column, which is months from peak to trough, as well as the last column, which is percent recovery of previous high. Because right now we're in an environment where Phil, we're already nine months in and we're still feeling pain. And you can see, on average, even if they get rid of the recession, non-recession, that's not important right now. You can see on average and median the length of pain has been between six to nine months. But look how variable it has been in that third column, as short as what we just went through in the great pandemic of 1.1 months. To what we saw during the technology, media and telecom bubble in 2000 and 2002, where it took 2 and 1/2 years for the S&P 500 to eventually find a bottom. So, folks, what we can't tell you is how long is this pain going to last? But what I really, really, really want you to take away from this is the last column when we eventually hit the bottom. You're probably saying to yourself, well, I would be really concerned if it took a long time for my money to come back. What you can see in the last column is that on average, in median, you got back more than 100% of your money 12 months post the bottom whenever that bottom hit. And even in some of those worst times, great financial crisis, tech bubble, the ‘73 to ‘74 drawdown, you got back 71%, 77%, 82% of the original high, not right off the low. So again, it's painful to watch when it goes down and it's variable, but more often than not, you get your money back faster than you think.

Phil: That's right. So that's peak to trough fall. What about returns during and after a recession? So let's dig right in. So these are the recession dates by the NBER. What do markets do actually beginning to end of a recession? And we know that markets are anticipatory. So often they're bottoming during a recession. They could be bottom before recession; they could bottom after a recession. But generally, on average, it's pretty, pretty incredible. First, recessions last an average of 10 months since World War II, S&P 500 returns saw positive returns 50% of the time, as you can see in the table, with an average of median return of 3.8 and 8.8%, respectively.

Brent: Right, right.

Phil: Even in negative events, the negatives, -8% and -1.5%. And look at ‘90, ‘91. That was roughly a 20% drawdown in the actual recession it was 7.9% up because the market bottomed pretty quickly and rallied. So it's not, we've had recent experiences like the great financial crisis. And the tech bubble of the last two recessions, non-pandemic, right, in which it took quite some time for markets to come back. That is not always the case.

Brent: Yeah, absolutely. And I think this next slide should really drill home how detrimental it is to your financial health to market time. Look at the average and median one-, three-, 5- and 10-year cumulative return post these 12 events. Significantly positive. And if I look at the percentage of positive observations, 92%, 100%, 100% and 100% of the time. So again, markets can be volatile. We don't know how long the pain is going to last. But sticking with it one, three, 5- and 10-years post, more often than not, you've been rewarded to a very high magnitude. So let's get to our bottom line. Let's talk about consensus views. First of all, suffice it to say, the broad consensus expectations is higher than where we are right now. Currently, 4,742 or about 17% above last Friday's close. Very variable in estimates. But again, the street is optimistic over the next 12 months.

Phil: In terms of our view, our price target remains 4,350. As of a couple of weeks ago, the market was about 2% from that price target. Market’s still down 7%, that's about 9% up from today. The way we get there is high single digit earnings growth with some pretty severe multiple contraction.

Brent: Yeah, so I think one of the things that we wanted to do is we wanted to talk about markets over the next decade. And I think the first thing that we want to do is gain some perspective. I want to give you some stats and just tell you how incredible the last decade was. For the decade that ended 1,231 of 2021, US stocks annualized Phil, annualized at 16.3% per year versus the long-term average of 10.8%. That's 51% higher than the long-term average per year for an entire decade, right. Inflation ran at 1.9% versus 3.2% and volatility came when I look at the VIX index at about 17 versus 20. So again, significantly higher returns, significantly lower inflation and volatility. That was the perfect cocktail for risk assets to grow. And while, and we've talked about where the consumer being OK for now and we covered a lot of these data points. I think the things that we can be concerned about is we've talked about ad nauseum, inflation running at multi-decade highs, market volatility is increasing, and we think is here to stay. And when we look at valuations across the board for stocks, bonds, currencies, we're at multi-year valuation highs even though we've seen some sell offs. What can we expect over the next decade? We believe for risk assets, stocks of all different sizes and styles and geographies, mid to high single digits over the next decade. Not the incredible double digits that we've seen is about reasonable for fixed income. We're looking at low to mid-single digit returns for a balanced portfolio. You're looking at mid-single digit returns with, which again, given everything going on is not that bad of an outcome. But again, relative to what we just went through, level setting expectations is really, really important. It's not going to be like the last decade.

Phil: That's right. So let's turn to a decade that comes up often in client conversations. It's referred to as the Lost Decade, 1999, end of ‘99 to end of 2009. So think you have the tech bubble, you have a modest recovery and think of the great financial crisis.

Brent: Yeah, nice bookend.

Phil: Yeah really, really fun period to be an investor. And to that point, why is it called the Lost Decade? Well, it's really about large cap stocks. So the S&P 500, during that decade, its annualized return was -1%. It's cumulative return minus nine, hence lost. Now, what's interesting is when you think about how we invest client assets and how most diversified investors invest and your eye moves down this table, whether you're looking at mid-cap or small cap or global equity non-US, these asset classes outperformed by 4 to 10% per annum.

Brent: Yeah, look at fixed income, 6.3% per year.

Phil: Aggregate Bond, 6.3% and with inflation at 2.6%. So really outside of large cap, you see positive nominal and real returns. If you think about a 60/40 portfolio, right, 40% fixed income, 60% globally diversified stocks, what, pushing 70% of the portfolio would actually have been up during the Lost Decade. So, yes, a very difficult time to be an investor, not something any of us enjoyed, but diversification did pay off during that period.

Brent: Yeah, and that's the moral of the story. It's not in or out, Phil, it's diversification and being thoughtful and forward looking. So one of the last slides that we wanted to show you we thought was very, very apropos, given all the head spinning and head turning events that we have going on right now, what we're looking at is investing $10,000 from January 1st of 1970, all the way through last Friday. And what you can see, Phil, is, you know, heads have been spinning for 50 plus years. There's always been a wall of worry. There's always been something to worry about. But the thing as it relates to investments is that it's very much about path dependent nature. It's about sequencing of returns. So think about where this analysis started. January 1st of 1970, we had two consecutive decades of ridiculously high inflation, and the decade of the 70s, we averaged 7.1% inflation, and the decade of the 80s we averaged 5.6% inflation. In this example, three years in, you had one of the top six largest drawdowns post the Great Depression. So talk about a bad start. Despite all of that, you went from $10,000 to $2 million over the last 50 years or an over 2,000% gain. So folks, it's time in the market, not timing the market that accretes to long term success and wealth. So, Amy, I can see all the questions that are piling up already. I'm excited to get to some of them. So why don't we jump in?

Amy: Sure thanks, Phil. Thanks, Brent. Yeah, we do have a number of questions. We also receive some in our registration. We'll jump right in. Phil,, this person would like more information around where the S&P will end at the end of this year. What are your thoughts there?

Phil: Yeah, so we can flip back to slide 33. Amy so, so our year end price target is 4,350 and not to be repetitive, but how do we get there? We get there thinking that earnings are going to grow this year, right? Call it 8 to 10%, give or take. And we have material, multiple contraction. So now this is 9% above where we are today. And you say, well, how do we get 9% in a few months’ time? But we've had multiple weeks of this year in which we've gained north of 6% in a week.

Brent: Yeah.

Phil: Right? We rallied 17% over—

Brent: Yeah, two months. June 16th to August 16th, exactly two months, we were up 17 and change percent.

Phil: So, look, we still have a cautiously optimistic price target. We came into the year at 4,900, which was well below consensus at the time because we expected multiple contraction. Obviously multiples contracted more. It has not been an earnings story yet. 2023 might be an earnings story, but so far it has been about what is the PE, the dollars you're willing to pay for a dollar of earnings?

Brent: Absolutely.

Amy: Thanks, Phil. So, Brent, let's talk a little bit about what effect, if any, the continuing political unrest may have on the short-term market.

Brent: Yeah, it's a great question, Amy, and it's one that we get a lot and we covered that a little bit. But when I go back to what's going on in Washington, D.C., we all have to remember that a midterm election is coming up.

Phil: Right.

Brent: Things are occurring. Statements are being made to make sure that each respective party placates their constituency. It doesn't mean that it's real, okay? And when we talked about governmental disposition, when I look at consensus expectations, odds are and again, anything can change. And I think we certainly learned that in the last couple of elections. But right now, consensus expectations is pointing towards divided government. Markets like divided government. And when you have Congress and the presidency being divided, right, guess what happens? Nothing. Nothing gets done. A lot of chatter, not much action.

Phil: And if it does get done, it requires a negotiation.

Brent: Exactly, right? Which would be a good thing.

Phil: Right.

Brent: But again, when you look at historical examples, the two consensus expectations, right. Republican house, Democratic, senate, Democratic president has seen the best market returns, not the worst. And then the next consensus expectations has seen the second-best expected return, or historical returns for the S&P 500. So again, it doesn't mean history will repeat. Anything can change in Washington, but I think many of the listeners certainly we're all concerned about government and the forward views of our country. But as it relates specifically to markets, we're more likely to be in a good scenario, not a bad scenario.

Amy: So Brent, Phil, can we talk a little bit about whether the current situation with the market is a headache what should, what should we be watching in the market overall in the next 30 to 90 days?

Phil: Yeah and Amy, if you’ll turn back to the chart that sort of shows year to date, S&P 500 and it’s bouncing around, is, look, as I look over the next 90 days and really through the end of the year, I think the layup of all layups is going to be really volatile.

Brent: So, yeah. So I think over the short term, right, while this has been a very macro and economically driven environment, right, sentiment tends to dictate very shorter-term price movements in markets. And there's just not enough, as you highlighted really nicely, there's not enough data for the markets to start to feel comfortable about the shorter-term nature. Hence we see some more volatility.

Phil: So let's turn to slide 18 Amy, sorry, I didn't have that number ready for you. So yeah, when you think about where do we go from here? And we had a 17% bounce, right?

Brent: Yeah.

Phil: You know, our feeling was that we had one good data point from inflation. Right and one month does not make a trend. Seemed like the market was potentially a little ahead of itself. Does that mean that we retest the lows? We certainly could, but that doesn't mean we do. Right we have seen past cycles where we don't. I think that it really is a macro driven market. We've already said that and as we were reminded by the Fed's comments last Friday, we need some directionality on the inflation front.

Brent: Yeah.

Phil: Right? And once we get that, I think the market will feel a sigh of relief. Until then, it's really hard to say that we just march higher from here.

Brent: Absolutely and again, in reason number four, when we talk about market recovery post the ultimate low, that's what investors need to focus on. It's never comfortable to see markets vacillate like they're doing. It's uncomfortable to see your hard-earned money go down temporarily. But as we've shown in many examples, with lots and lots of historical data points, with lots of events going on, understanding that the pain is temporary. And the gains are longer term. So again, stay invested, have a financial plan, don't worry so much about that. You should be focusing on, do I have a diversified portfolio, for sure. Do I have a financial plan? Absolutely, if you don't have either one of those, then yeah, you probably do have a problem and you need to speak with us about that. But again, we can't tell when the bottom actually is, focus on the percent recovery here of the previous high.

Phil: Yeah.

Amy: So Brent, we have a lot of questions from folks who are closer to retirement or possibly in retirement that are concerned about the very near term, the next three to five years. Can you talk a little bit about what they should be thinking about and doing at this point?

Brent: Yeah, Amy. I mean, it is a phenomenal question. And it's a question that I'm getting like every day from folks that are nearing retirement or just entered retirement. And this is why, and I say this all the time, as folks that are involved in investments, planning is the single most important thing that you can do to make sure that you understand where you're going, right? When we talk about investing in stocks, right. Given the variability what we're seeing going on right now, you have to be or have a time horizon of five years or more. And we've covered that in pieces that we've written that are available on firstcitizens.com. How not to get eaten by a bear and some other pieces that get into those reasons why. But sitting down with the financial planners, sitting down and understanding and having that cash buffer or understanding your liabilities in your cash flow needs between now over the next three to five years and making sure that you aren't pulling to the extent that you can from your invested assets when the markets are down, that will exacerbate the time to recovery. Having diversification in those cash buffers and being able to understand where you need to pull your money from when times like these occur will make or break your financial success. So we think the number one thing is to think about and sit down with your planner to map that all out, have cash reserves or fixed income reserves to mitigate liabilities over the next three to five years. But again, stay invested. Think about how you felt in the great financial crisis. Think about how you felt in the technology bubble. Think about how you felt in the pandemic. You recovered, have the plan, have the cash buffer in place, and you'll be okay.

Amy: Just got a really good question in the chat around, we talked about how the fixed income market has been struggling and the S&P has obviously had some volatility this year. Where is a person to turn at this point? What do you think about that?

Brent: Yeah, I think that that's maybe, I'll just let you go first, Phil.

Phil: Yeah look, markets, markets have sold off. That does not mean that forward returns are going to replicate the last nine months, right? So taking fixed income, which you mentioned initially or the person who asked the question did, look at where yields are, right? The AG is yielding the Aggregate Bond index yielding 3.8%. It's actually higher expected returns in fixed income than what we've seen in years.

Brent: Yeah low fours and low fives.

Phil: Right and same thing with stocks. If you're a long-term investor, which if you own stocks, those should be long term investments. The truth is, this is a better entry point than where we were nine months ago based on valuation or other metrics over the long term.

Brent: Yeah, and I understand the question from the listener is normally bonds have been, you know, that, that ballast in the portfolio when risky assets get volatile the bonds are there to protect. Well, it's not a guarantee. It's not it's not a guaranteed insurance policy. There are periods of time where stocks and bonds do move together. That doesn't mean, that doesn't mean that you abandon diversification. It's just not working now. But to your point, right, you know, expected returns for fixed income look much better. And again, a lot of times when we build portfolios for clients, again, when you're holding that fixed income instrument and you know, you hold it to maturity or whatever, you know, you're going to get that yield, you're going to get that return. It is about diversification. It doesn't always work together. But the alternative is, is what? Right, you don't go to cash, then that's time in the market. And we all know that you can't time the market. So it's having a plan, staying thoughtfully diversified and understanding that sometimes things don't always work.

Phil: Right.

Amy: Thank you both. So as you both know, the Inflation Reduction Act was passed by Congress recently. I've got a couple of questions coming in around, will it actually reduce inflation? What are your thoughts?

Brent: Yeah so broadly, let's take a huge step back and let's talk about what are some of the drivers of inflation and Phil covered it nicely. The Inflation Act is not going to end the war in Ukraine. The Inflation Act isn't going to fix broken and damaged global supply chain issues. Right, that act is not going to necessarily lower gas and food prices over the short to intermediate term. Right, so I would argue that a lot of the key components of that act are going to have little to no effect over the short to intermediate term as it relates to inflationary pressures. Time will tell over the longer term whether or not that will be advantageous or not. But again, like we said, it's a mid-term election year.

Phil: Right.

Brent: People say and do a lot of things to give the view that they're doing the right things for the economy. Unfortunately, I think this time around, things have to be repaired by themselves. There's not a lot that policy, fiscal policy like this can actually do.

Phil: Look, global forces are driving inflation, right, and monetary policy can probably have more impact than fiscal policy. But even monetary policy is somewhat limited when you're talking about global port shutdowns. Right, in China, for example, or the war in Ukraine. Unfortunately, policymakers, their hands are tied on some of this. But what they can do is attempt to slow the economy and thereby bring down inflation. When you think about things like the price of gas, housing, et cetera. But there is no easy solution, particularly on the fiscal front.

Brent: And I think you're bringing up a really good point, Phil, is that while no one really wants to see a recession, significantly reducing the demand component will ultimately, we think, bring down inflation. Right, when you bring down that demand impulse, unfortunately, sometimes you do need a little bit of a recession, or at least a growth slowdown to see inflation continue to moderate from here. So, so, time will certainly tell, but it's hard to see how fiscal policy by itself can fix it.

Amy: Well Brent, Phil, thank you so much for all that information and for answering questions today. We are just about out of time, so we'll go ahead and wrap up. I want to remind everyone that our next Making Sense webinar is September 28th at noon Eastern. We'll be sending out some information shortly about that. On behalf of all of us here at First Citizens, I want to thank everyone for joining us today and trusting us to bring you this information. That's not something that we ever take for granted. We hope to see you again next month and we will see you then and hope you have a wonderful holiday weekend. And thanks again for being with us.

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