Planning · August 01, 2022

Making Sense Webinar: July Highlights

Brent Ciliano

CFA | SVP, Chief Investment Officer

Phillip Neuhart

SVP, Director of Economic and Market Research

Making Sense: July Highlights webinar replay

Amy: Hello, everyone. Welcome to the First Citizens 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 with First Citizens Bank. And while everyone's signing in, I want to share a couple of housekeeping items with you. First, today's webinar is being recorded, and a replay will be sent to you following this conference. Secondly, this webinar is interactive. If you'd like to ask 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're not able to answer your question during today's call, 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, Amy, thank you so much. And good afternoon, everyone. Phil, so, so much for the dog days of summer and more sanguine market volatility. We've seen heightened equity market volatility, fixed income volatility, currency volatility. So it seems like people aren't taking that necessary vacation.

Phil: Right.

Brent: So what are we going to focus on today? Phil and I are going to be laser focused on the consumer. We're going to talk about the resilient labor market, but we're going to also talk a little bit about how inflation might be feeding back to consumers, to consumer spending. Then we're going to talk a little bit about corporate earnings. We're right in the middle of earnings season, so we'll talk about that. But we're really going to hit inflation in the Fed. For the second time, Phil, we're doing our WebEx on Fed Day, so you're going to have to wait until 2 this afternoon to find out a little bit more as to what the Fed's going to say and the decision that they're going to make. But we're going to give you some insight. Then we're going to talk about where markets go from here. We'll talk a little bit about the questions that our clients are asking as it relates to where might some of the floors under the market be and where do we go from here? But interestingly enough, after this Friday, Congress goes on recess. They're going to be gone for much of August. But when they come back, they're not going to be legislating. They're going to be campaigning for re-election. So we'll talk a little bit about markets and midterm elections and then we'll give you sort of our prognostication as to where markets go from here through the rest of the year and beyond. So why don't we jump in, Amy, and get to the economic update.

Let's talk a little bit about the labor market. And despite the slowing economic growth that we're seeing not only, Phil, in the United States but abroad, the labor market has been very resilient. Next Friday is jobs day, right? Jobs have been very resilient. For June, we saw 372,000 jobs. The 6-month moving average has been almost half a million jobs. We need only about 150,000 jobs-ish to keep the unemployment rate from growing. So the labor market remains significantly tight, and job growth has been resilient. On the bottom when we look at job openings, we hit a historic high back in May. And as of then, we saw about 11.3 million open jobs. Next week, we're also going to get an update on the number of open jobs. We're probably going to see that number come back down a little bit, but we still remain at historically high job openings. So the confluence of job growth as well as job openings sort of portends still a robust labor market. So when we talk about the consumer and we look at also another data point, Phil, that's going to be updated next week on the left-hand side, we're looking at average hourly earnings. Average hourly earnings, while you can see on the graph has been moderating, sitting at about 75% higher than the 15-year average of 2.9%. The problem, though, and we'll get to in a minute, is the ravages of inflation. After 9.1% inflation, we're seeing negative real wage growth unfortunately. On the right-hand chart, actually, over there, the right-hand chart we're looking at, inflation is starting to feed back into consumer spending and we're seeing outstanding credit card debt starting to really pick up. Well, it's coming off of a reasonably low base. The year-over-year change in spending on credit cards is really starting to pick up, which is basically saying inflation is starting to really hit home and feeding back into consumer spending.

One of the things that we're looking at, you can see on the left-hand side, is the University of Michigan's consumer sentiment—how you folks on the phone and on the WebEx here are feeling. And you can see on that graph, we're sitting at the lowest level ever for consumer sentiment. This data, Phil, goes all the way back to the mid-1970s. So it is interesting and it's the same three things that we were talking about last time, which is multi-decade high inflation, global supply chain shortages—but also discord in Washington, DC, that's leading to the consumer sentiment, and it has ticked down. When we get to the market section, we're going to talk about what might, this might portend as far as forward performance for the S&P 500 going from there. On the right-hand side, when we think about what that might impact, which is spending, the gold line on the right is spending on goods. The gray line is spending on services. And what you can see is that both spending on services and goods remains materially above the 20-year average. But we've seen a fundamental shift spending on services and away from goods and actually, inside of goods spending when you look at some of the earnings reports that came out of maybe some of the big-box retailers, spending within goods has changed where we're spending more on food and necessities away from things like home furnishings and electronic goods. So the disposition of what consumers are spending on has changed materially. But the good news is, Phil, they're still spending.

So moving that forward and let's talk a little bit about corporate earnings and profitability. As I mentioned, we're in the midst of earnings season and I think the tone so far is moderation in actual earnings and earnings outlooks, not something that's falling off the cliff. And we've seen some earnings reports as recently as last night from some of the technology behemoths. We're going to see more this evening. But by and large, consensus believes that earnings for full year is going to moderate to about 9.8%, which is down from 10.2 that we saw at the end of May. But above where we were at the end of the first quarter for this quarter, a little bit slower growth, about 4.8% for this quarter. That's actually up from about a week or two ago, which had us about 4.2%. So analysts' expectations are certainly coming down, but they are absolutely not falling off the cliff. So it's more of a moderation than a cliff-falling exercise.

Phil: Right, and to that point—if we turn ahead—companies are beating in terms of top line and bottom line, but they're beating a lowered bar from that 4.8% growth. What we are seeing, if you look at the transcripts of company reports, what are management teams saying? Something we watched carefully during earnings season. Well, one, they're citing inflation and higher costs. That is not surprising. This is really coming up in every report, virtually, something we'll dig into more in a moment. And they're still citing shortages to a little lesser extent than they were in recent quarters. But nonetheless, shortages remain a major theme. And something that there's hope that as we enter late this year, early next year improves. But the truth is, we're in sort of a show-me mode at this point when it comes to shortages. So let's dig in to that inflation that companies are citing. So the left side here is the Consumer Price Index year-over-year percentage change. And we show this chart regularly in these webinars. You can see consensus estimates going forward. So while the consensus has inflation declining, the rate of inflation declining, it's all elevated, right? The Fed's target is 2%. Nothing here is below 2%, and also the rate continues to move upward in terms of being revised upward. So when we last met that fourth quarter 2022 number was 6.5%. That's now 7.2%, so in a month consensus moved up 0.7% in terms of inflation. So this is what the Fed's fighting. And when you look at the Fed meeting this afternoon, Fed Funds Futures are pricing 75% chance of a 75-basis point hike, 25% chance of a 1% hike. So really, 75 is the base case, but certainly a real chance they go 1%. Currently, the Fed Funds Rate is in the range of 150 to 175 basis points by year end. As you can see on the right side, futures are pricing more like 3.5% from where we are today. So in other words, they're hiking today and they're going to continue to hike. Now, if you believe futures—and we tend to—much of their work is going to be this year, right, a lot of hiking this year. There's a chance that next year they're on pause or potentially even cutting as the economy slows.

Brent: Yeah, and to your point, Phil, there's a lot of variability that we've seen in this data. And certainly there's been an awful lot of talk about peak inflation. And while that might be true and maybe we'll knock on wood that we are there, to your point, Phil, levels are elevated. So the extent to which they would have to moderate from here to get closer to that Fed's 2% target-ish is still a long way to go.

Phil: A long ways to go. So let's dig in further on inflation. So here we're showing pre-pandemic and today, so December 2019, before all the disruptions of the pandemic and the recovery from the pandemic, inflation was running at 2.3%, as you can see here. And we're breaking out what made up that 2.3%. So half of it was shelter. Energy was only 10% of inflation, food was only 11%, motor vehicles and parts, it's actually a very sliver just below the line there because it was negative, right? It was deflationary, which is a reminder that you can't get negative in inflation data. The picture has changed dramatically on the right side. So this is the most recent report, inflation of 9.1%, just astronomically high. And the composition has changed. About a third of it is energy. Food is 16%, shelter, which is stickier, is still there. But some of these components, fortunately, can come back down. I want to spend a moment talking about energy prices, if we can flip ahead. So this is retail gasoline prices, something that we all see every day on our drive to work. There is really nothing like gas prices that we are so aware of day to day, whether they're moving up or down.

Brent: Put $100 in this morning, so—

Phil: That's right. We are very aware more than maybe any other price we have. Now, first, you could see gas prices move around a lot.

Brent: Yeah.

Phil: Very volatile. Not sticky. They move up. They move down. Recently, you can see the slight move down. But what makes budgeting so hard is that you don't have a level price move and things like retail gas is so volatile. So as an example, if you took the 2008 peak and compared it to the recent peak. Annualized inflation peak to peak is only 1.4% annualized. Right, really modest. If you could budget for that, that would be great. Unfortunately, what happens in reality is gas prices come down, they stay down for years and then gas prices more than double that really hits budgets. The Census just released a household poll survey worth checking out—40%, 40% of adults are having difficulty covering their usual household expenses.

Brent: Yeah.

Phil: This time last year, that number was 27%. So when we talk about the use of credit cards, as you said, Brent, this is having an impact and is certainly painful.

Brent: And I think it's really interesting. You talked about how volatile some of those components that are making up a larger share of that 9.1. And you think about energy, we saw WTI move all the way up to $125 a barrel, and now we're down about $94/$95 a barrel, which is almost a 20% drop. So highly volatile. And I think the thing that makes me feel good about looking at a chart like this when you take that time series back, to your point, that was well said. And when we get the high levels, you don't stick around at those high levels for very long.

Phil: That's right. And then that, of course, is the hope. So let's turn ahead to housing—something we get a lot of questions on in client meetings and then Q&A in this session as well is housing and what are we seeing? So we want to give you some current updates there. First, homebuilder sentiment has really deteriorated over the last two or three months. Homebuilders are citing, one, the impact of higher mortgage rates, lower affordability, higher input costs and supply chains. So when homebuilders' sentiment falls, we pay attention to that because they are on the ground and they are a leading indicator. Existing home sales are slowing. There's just no doubt about it. Nationally, when you look at sales, we are seeing slowdown. We're seeing the same thing in new home sales and we're seeing the same thing in housing starts. Now, home supply still remains pretty tight, and housing is always geographic. So where you are matters when it comes to housing. What are the population trends of where you live? But a lot of the froth—even if we speak to where we live in Raleigh—a lot of the froth in the marketplace is starting to come out. That does not mean that we're seeing severe softening yet, but the slowdown is bringing some of the irrationality out of the market.

Brent: Yes, and we saw some of the pricing this week and on an average, you point a national, at a national level, you're not seeing that fast of a moderation in prices. I think the one thing that did strike me is, you know, we certainly have a lot of folks on the phone, on the WebEx, Phil, that are looking at commercial real estate. It was interesting to see how much commercial real estate came off. And it seems that there's a little bit more of an acceleration in the decrease in commercial real estate, less so in single-family, multi-family homes.

Phil: That's right.

Brent: So let's talk a little bit about the possibility for recession. We get so many questions. Are we in recession? Are we going into recession? Where are we right now? And we're going to get into that in just a moment. But one of the things that has tend to portend a looming recession is when we have what's called yield curve inversion—and we think about the normal yield curve, we're talking about when shorter rates tend to rise above and exceed longer-term rates. Specifically here, we're talking about the differential between twos and tens. And what we're looking at here is the last 60-plus years of that yield curve inversion. You can see we've had 10 observations and they're the dots. In eight out of those 10, we had a recession follow along shortly thereafter, we had that yield curve inversion on average about 13 months. The yield curve inverted in early April this year by only about six basis points. But we started to see yield curve inversion materially occur earlier this month and we're sitting at about 20-ish basis points inverted now today. So again, if history were to repeat, it might mean that we could be seeing a recession on average anywhere from 12 to 13 months from here if history were to follow along. So to that point, Amy, why don't we go to the next slide and let's kind of bring it home as it relates to recession? No go or not?

Phil: Yeah, so a slide we've been showing for months now. I want to give you an update in terms of what we're thinking in terms of the risk of recession. Where we are now is really in the next 12 months. It's a coin flip, 50% chance of recession. Last time we met, it was 45%. So again, we've been sort of around coin flip for some time, but we have upped that when you look at things like the yield curve, that really to us is eye opening. But what's important is if you can speak to this, Brent, is if we are in recession—which, by the way, GDP comes out tomorrow morning, we're going to have a lot more color at 8:30 Thursday morning. In terms of this, it's a unique one when you think about things like the labor markets, consumer spending, et cetera. So you could speak to this is a strange recession if we are in.

Brent: It is. And when you think about it, let's pretend tomorrow we wake up and we end up with a first print that is negative for the second quarter. Just because we have two consecutive prints of negative GDP growth does not mean that the National Bureau of Economic Research is like, hey, we have a recession. There's other factors to your point that go into it. The most important thing, I think, for both of us is if we do have a recession—and I think it's a matter of when more so than if, right? We believe that because of the strength of the consumer, strength of corporate earnings and profitability, and where we've engineered ourselves too, that we believe even when it does happen, it will be short and shallow, not deep and protracted. I think that's the biggest thing. And if we do wake up and we're in recession, I'll ask you on the phone, well, how do you feel right now? Right? I mean, if we are in a deep and protracted recession or the expectation for deep and protracted recession, there's a higher likelihood that you would be feeling that more than what we're feeling today. But again, anything can happen. Things change very quickly. But that's kind of where we are right now. We're going to continue to update this in the coming WebExes.

Phil: That's exactly right. So that's the economic side. Let's look at markets and where they might go from here. So, first of all, this is a simple chart—we're just showing the S&P 500 year to date. And the real question here is we're down about 18% through yesterday. We are up today, but really is the fourth time the charm in this drawdown, which has been volatile? We'll talk to that more in a moment. You have seen a 6% rally, an 11% rally, 7, 8% recently and just in individual weeks on the right side, 5 trading day, 6.2% week in March, 6.7 in May, 6.5 in June. So we're regularly seeing weeks north of 6% in one week. So when we talk about things like price targets, and we talk about, how can the market possibly rally 10-plus percent? Well, it could do it in a week-and-a-half is the answer. And that also is a reminder of time in the market. Predicting these things is very hard. It's easy to forget that the market rallied 11% in the March-to-April period.

Brent: That's right.

Phil: 11% rally. Difficult to call. So we'll talk about more when we might be reaching a bottom in a moment, but something to note. So let's speak to that volatility on the next slide here. So it certainly felt like we bounced around a lot and the data says that. So this is the percentage of days in which the S&P 500 has moved greater than 1% up or down. Right, we're at 90% right? That matches—

Brent: 80% of all trading days. You'll see the heightened volatility.

Phil: That's right. That matches basically the highs since the early 80s. And note just how low it was for a number of years prior to this year, the one exception being 2020, which was the pandemic. But 2017, 4% of days moved more than 1% one way or another.

Brent: It's no wonder why investors are feeling that volatility and that anxiety as it relates to this market volatility, because it really hasn't been present for the last 5 years.

Phil: That's right. And a couple of things to note. First of all, when you see the extreme highs in the past, there is some clustering. It would not be wild to think we have some volatility entering next year as well. Additionally, just because you have big swings does not mean it's necessarily a bad year in the market.

Brent: A lot of positive plus 1% movements in those years.

Phil: 2020 is a recent example.

Brent: Exactly.

Phil: A lot of volatility, but actually on net was a good year just with the pandemic in the first quarter. So let's talk about levels of the S&P 500.

Brent: This is probably the most asked question that we get. Phil, Brent, where's, where's the floor under these markets?

Phil: That's right. So first of all, there's a chance we've seen the floor, right? You know, sort of peak to trough declines north of 20%, but let's look at valuation and let's say we fall further. What sort of level might we see? So the average here in recent years, since 2014, about 15 times or the bottoms you see here, where we are today, that would indicate a drawdown to about 3,540 on the S&P 500 at that 15 times. At 14 times, you end up down about to 3,300. So you can see further drawdown from here at those floors. But that 3,500 draws about another 9, 10% from here, not an extreme drawdown and really would say that a lot of the wood has already been chopped.

Brent: Yeah, and I think the important key in what Phil is saying is that also assumes that earnings remain constant at the level that they expect them today. If we do have some variability. And as I was saying earlier, earnings, maybe the luster comes off a little bit and we fall from 9.8% growth to maybe 8% growth. It only takes those levels down a little bit down to like 3,480 or 32 and change. It's not a major dropoff from there. So even if we have earnings variability that affects that denominator, the underlying levels from a valuation perspective under this market are still around that 3,500 and 3,300-ish level. So to that point, one of the things that I wanted to talk about, I talked about the University of Michigan consumer sentiment survey. This is that exact same chart. But what we're putting in here, you see all those little blue dots? They are sentiment highs and lows. I want you to focus your eyes below the blue dotted line and go back over the last 50 years and look at all of those consumer sentiment lows. Next to those blue dots, we're showing you what the next 12 months S&P 500 return was and what you can see on average, 12 months off of sentiment lows. The S&P 500 averaged a whopping 25% return. The smallest recovery that we've had 12 months post a sentiment low was 14.2% back off the October 2005 low. So again, if history were to repeat, we have seen a trend over the last 50 years that equity markets have done actually better 12 months post sentiment lows—not worse—which might be counterintuitive to a lot of investors' thinking that, geez, well, consumer sentiment drives investing and flows and things along those lines. That hasn't been the case historically.

So one of the things that we talked about a little bit was midterm elections. After this Friday, Congress is gone. When they come back, they're not going to be legislating. They're going to be campaigning. And let's talk about S&P 500 and equity markets as it relates to midterm election years. What you're looking at here in the red bars below is every midterm election post 1950. And what you can see is that the average intra-year drawdown during midterm elections has been -17%. What have we hit so far? -22.5%. So we are very much in spitting distance of the average intra-year drawdown during midterm election years, which have been historically more volatile than non-midterm election years. But what's important here is when you look at the blue bars, that's the 12-month recovery in the S&P 500 post those intra-year drawdown lows. And you can see some of those very high bars on the next slide when we talk about what we've seen post midterm elections, and you can see that graph on the left where you can see this year's following right in line with the average of midterm election years volatility from March all the way through kind of that early fall. And then from midterm elections, it's been a hockey stick up. When I look at the S&P 500 return post every midterm election since 1950, the S&P 500, Phil, has been positive, 100% of observations post midterm elections with an average return of 15%. So this time around, so think November of 2022 through November of 2023. Again, if history were to repeat, let's knock on wood and hope that we get a positive return. One of the questions that we get a lot on the next slide is, well, Brent, will the midterm elections, will discord in Washington, DC, actually confound markets? Will markets sell off because there's just so much strife going on in Washington? Well, folks, it's actually the exact opposite. So what we're looking at on the top left-hand chart is the underlying disposition of Congress and the presidency over the last 100-plus years of data and, right now, consensus expectations: Democratic president. Right now, when we look at the consensus, we're looking at potentially Republican House after midterm elections and Democratic Senate is currently the consensus call. Lot can change. A lot's changed a lot. But when you look at the grade—so the green callout box—the best-performing congressional makeup is exactly that. We've seen an average of almost 14% returns per year when you've had divided Congress where you have a Republican House, Democratic Senate, Democratic president. The next consensus call happens to be the next bar on the right there, 8.4% return, which is an all-Republican Congress and a Democratic president. So current consensus expectations post midterm elections and the disposition of Congress actually, at least historically, has seen the better market perform, performance, not worse.

Phil: So it appears the market likes a little bit of gridlock in Washington.

Brent: That's right.

Phil: Potential for negotiation, split Congress, first executive branch.

Brent: Exactly, and on the bottom right, the red bars are when we have a newly elected president. And so we're looking at the presidential cycle, years one through four. Interestingly enough, the historically, the best year for markets when you have a newly elected president—which is what President Biden is—has seen the strongest equity market returns in the context of that presidential cycle.

Phil: So let's switch gears a little bit and talk about resisting the urge to go to cash.

Brent: That's right.

Phil: So here, something we talk a lot about, but I want to share this chart with you all. So if you had $10,000 in 1960 and you were an equity investor and you invested it by the end of 2021, that is $4.97 million, which is just—

Brent: 5,000 times.

Phil: Right. It is the wonder of compounded return. Just absolutely wild that is if you're an equity investor for your balance investors 60/40 $2.52 million, if you were just bonds $884,000. Just to give you a sense. Now, if you were a reactionary investor, in other words, these six periods, only six periods, but six periods where you—

Brent: Little panic button that you're showing.

Phil: The panic buttons you sell when the market's down 30% and you don't come back in for 2 years, which is what studies show generally—when investors exit the market, it's very hard.

Brent: Especially with those big drawdowns.

Phil: Yes, it's very hard to get yourself back in, right? So behaviorally, 2 years, if you do that, that's the red line. And you are at $550,000 compared to $4.9 million.

Brent: 90% less.

Phil: That's right.

Brent: Yeah, and what blows my mind is over this 60-year period, Phil, there's only six times where you would have potentially hit that panic button where we had a drawdown of 30% or more—not 60 times, six times in 60 years.

Phil: That's right.

Brent: So very, very infrequent. But the price that you pay to step out of the market behaviorally is an incredibly significant one.

Phil: That's right. And more to that point on the next slide, looking at staying in the market at the same concept here. But 1992, if you had $10,000, you were fully invested in all days, the S&P 500, that translates to $208,000. It's still pretty unbelievable, right? Now, even more incredible if you missed just the 10 best days in the market.

Brent: At a 7,000 trading day.

Phil: Exactly, thousands of trades team is 10 days. That number falls to $95,000 or 54% less.

Brent: Crazy.

Phil: 20 trading days, that number falls 73% to $56,000. So again, it is very hard to time markets when you look in the box here. Nearly half of S&P 500's strongest days occurred during a bear market.

Brent: Yeah.

Phil: We just showed rallies in bear markets, right? Another 28% took place in the first two months of a bull market. No one knows you're in a bull market in the first 2 months. It may just be a bounce like—

Brent: That's right.

Phil: Today.

Brent: That's right.

Phil: So again, it's very hard to stay in the market, but it does pay dividends in the long term. So we talked a lot about stocks. Let's talk fixed income for a little bit here. So first of all, really difficult start to the year. We've talked a lot about this. I will not dwell on it, but multi-decade difficult starts the year we as investors are conditioned especially over the last four decades to expect when stock sell down for bonds to rally.

Brent: Bonds are your ballast.

Phil: That has not been the case. The bond market was caught flat footed in terms of the degree to which the Fed would need to hike. Interest rates went up. When interest rates go up, prices go down. So something like the US aggregate down 8.7% through late July. Now the good news is one yield has increased. So now the US AG 3.5%, IG Corporates Investment grade corporates 4.4%. Those numbers just 7 months ago were 1.75% and 2.3% so we are seeing this, we're seeing this in our client base, clients' interest in, hey, can I get some yield now? And the answer is yes. Additionally, if you talk to our fixed-income team, there is compensation for duration risk relative to where we were just a few months ago. You are seeing compensation for duration risk, so that's a positive. But of course, the negative is the price return.

Brent: Yeah, and I think longer term, Phil, in the context of forward-looking capital market assumptions and in balance portfolios—which the vast majority of clients don't own all stocks or don't own all bonds—you usually have a balance in the context of your portfolio. Just 7 months ago, the 10-year forward expected return for fixed income had ranged between 1.2 to 1.7% per year for the entire decade. Those if I look at some of the consensus of those, you're now kind of in that 3% to 4% range for the next decade, which is materially higher, which shows you two things: One, that expectations can turn on a dime. And now that the context of what fixed income can do in the context of a balanced portfolio is likely to carry a more significant weight for portfolios over the next decade.

So let's bring this home, because I literally can see all the questions piling up that you're all asking, and we really want to get to those. So let's get to our bottom-line views on the markets. Let's start first with consensus, and this is bottom-up consensus, Phil, so, all these analysts looking at the individual stocks aggregating to an implied value for the S&P 500 over the next 12 months, 4,785. So that's about a 21% return from last Friday's close of 3,961. So it's a hefty way to go. But the good news is, broadly, consensus is more optimistic about the next 12 months than pessimistic. Where are we—and we've covered this the last couple of WebExes—we believe that this year we're going to hit about 4,350 on the S&P 500, which is about a negative 8.5 to 9% decrease over last year's close of 4,766 on the S&P 500. How do we actually get to that? It's made up of two components. We see 8% to 10% earnings growth. As I told you earlier, we're sitting at about 9.8% today. But what we're also looking at is the price that investors are willing to pay for a dollar of earnings has contracted so far year to date, almost 30%. It's overdone, in our opinion. We're looking at about 15 to 20%, multiple contraction in the price that investors are willing to pay for dollar of earnings. You put those two things together, that's how you get to the price target of 4,350. Within our views, we do believe, and we've certainly seen value stocks do well as the economy was strong. We have energy in that complex and certainly energy with higher inflation has done well. But we're starting to see a shift where growth is starting to outperform value. When we look at our forward-looking capital market assumptions over the next 3 years, we do see growth outperforming value. We see quality doing well, we see dividend-paying stocks doing well. But broadly within the complex we see down in cap, we think about mid-cap and small-cap stocks versus large-cap stocks over the next 3 years. And we're starting to see at the margin, international specifically, in emerging markets, looking a little bit more attractive. A lot of that because prices come down materially, but we're starting to see that become a little bit more attractive. But again, a long way to go for the broad international complex to do better in the future. But we're starting to see early stages. So with that, Amy, that was a mouthful. Why don't we get to some of the questions?

Amy: Yeah, thank you, Brent. Thank you, Phil, for all of that information. Just a reminder to everybody, if you have a question you'd like to ask, please use the Q&A or the chat feature on the right-hand side of your screen. We also received a number of questions in our registration process. We'll start there. There's one here that really, I think, encapsulates the way a lot of people are feeling right now, Brent. Inflation continues, markets fluctuate, recession imminent, Fed increases rates. What's a retiree to do?

Brent: Yes, quite, quite a conundrum. Look, I think this is what exemplifies what I think we do best, which is help our clients plan for the future. So whether you're in accumulation mode or like the person who asked the question in retirement or nearing retirement, having a thoughtful financial plan to make sure that you can think through all the things that are incredibly important to your retirement is absolutely what we believe people should do. What I want to highlight is, is the slide that Phil covered, which is look at investing $10,000 back in 1960. Sixty years later, you had $5 million, which is like 5,000% gain. Just incredible what history did. Right, think to yourself as a retiree or as an investor, what are all the things that happened in the world between 1960 and today? Wars, pandemics, economic cycles, political strife—you name it. It happened during this period of time. And at the end of the day, sticking with the plan, having a balanced portfolio, sticking with the equity markets through thick and thin has accreted to significant wealth over time. So I would tell that retiree, start with a financial plan, stick with that financial plan, read some of our resources like how to not get eaten by a bear. Keeping your eye on the prize. Making sure that as you're nearing retirement or in retirement, you have enough cash ballast or fixed-income ballast to weather the storm so that you can pull from that as opposed to your equity or risk assets when the markets are down, which could exacerbate your drawdown. But it all comes back, Amy, to having that plan and sticking with the plan is, we believe, going to allow investors to get through this current storm.

Amy: So I'm seeing a lot of questions. This might be something you both want to comment on. I'm seeing a lot of questions around what's going to happen in the second part of the year, where we may end up at the end of the year. And I also have a question about where is the best place to hold cash while waiting for the clues of the bottom? Do you want to speak to that?

Phil: Sure, so I'll take the first part and then maybe you handle cash. The in terms of where we might end the year, what Brent just outlined our price target. That's up about, what, 9, 10% from where we are today. So, so, we remain cautiously optimistic. Now, something I pointed to was some valuation bottoms, right? So remember, valuation forward valuation is just what you're willing to pay for a dollar of estimated earnings.

Brent: That's right.

Phil: That's all it is. And if that were to come down, potentially, you see a few 100 points lower, lower level than where we are today, 3,540, maybe 3,300. But the real point is focus on the long term. If you're an equity investor and you're a client of ours, likely these are longer-term assets where the market goes the next 5 months. It's good to know, but, but, at the same time should not be critical to your plan. Focus on the long term. But again, we think there are reasons post midterm election where consumer sentiment is. We do think there are reasons for cautious optimism.

Brent: Yeah, and I think it's critically important. And I think investors constantly wrongly conflate these two things. The markets are not the economy, and the economy are not markets. Full stop. Let's just go back to where we were when it was really bad during the pandemic. The market bottomed on March 23 of 2020 when we had just lost the most amount of jobs in the history of our country. We lost 22.4 million jobs in 2 months in March and April. We had no view into having a vaccine or what was going on. We were wearing masks on our heads, washing groceries. It was a mess. Yet the market found a bottom when there were no clear signs. And there should have been. Right, so understand that the markets and the economy move in different paths relating to the question that you asked and that actually the person listening in asked. As it relates to cash, I want to be very clear. If you're fully invested and you have a plan, do not go to cash. That's, that's an issue. Do not market time. We don't believe that adds any value. If anything, it destroys value. If you are sitting on cash because maybe you sold a business, you've come into cash. You already had cash on the sidelines, to Phil's point, across the entire yield curve, whether that's investment grade, corporate bonds, whether that's treasuries, governmental debt—there are way, way, way more opportunities today than there were 3 months ago, 7 months ago. So definitely talk to your First Citizens Bank representative. There's absolutely some exciting things that we can do for you within the fixed-income space as it relates to managing your cash to get you some pretty significant returns on that cash while you're waiting to do whatever you need to do as it relates to your plan or your business.

Phil: Right, and on the business side, a lot of clients have reserves, right? This is money that needs to be in fixed income in their view. Finally, there's some yield.

Brent: Yeah, we're doing some exciting things for corporations right now, today with fixed income.

Amy: I know we touched on this, but I do want to hit on it because I think a lot of people are interested in the housing market, as we mentioned, is North Carolina home market. Is the home market beginning to soften as the pandemic lifts and interest rates rise? Our supply is more in line with demand, Phil.

Phil: Right. So, so it's a great question and something that there's some data, but some of it's anecdotal as well. So, so first, some of the national trends, right? Interest rates, mortgage rates going up, affordability going down because of home prices, that those hold true in North Carolina as well. Some slowdown in terms of sales, that holds true. What is the case in North Carolina, though, is that supplies are very tight. Population trends are very positive, and that provides some support. Now, when you say softening, I do think some of the froth is coming out of this marketplace. And we're hearing that from our client base. We're hearing that from our neighborhoods. Some of the, let's say, irrational exuberance that was in some of these metro areas we do see coming out. So in that way, yes, there's a softening that might be healthy is, is, the truth.

Brent: Longer-term sustainable growth. Taking some of that froth can lend to potentially a longer cycle.

Phil: That's right. The fundamentals for North Carolina remain in place. That does not mean that some of the national trends in housing, trends in housing, North Carolina would not feel. Certainly well-positioned for the long term in terms of real estate.

Phil: Absolutely.

Amy: Brent, we've mentioned several times today that the Fed is meeting this afternoon or sharing their results. This question is around midterm elections, putting pressure on the Fed to keep rates lower. What are your thoughts there?

Brent: That's a great question. Well, let's just talk about where we are right now, Amy. The Republicans need to take four seats in the House. To make it divided Congress—like the charts that we just showed previously—the current consensus as of last Friday is the Republicans will take anywhere between 35 to 45 seats in the House. They only need to move four. The Senate's more of a jump ball right now, Amy. So, so, it is a little bit unclear as to what that might look like. I will say that we're going to be having Dan Clifton down here in Raleigh in October to talk more deeply about what's going on. I know between now and then, we're going to be working more of elections into our commentary and into our WebExes. So more to come there. I actually believe—and I want to believe—that by and large the Fed is relatively independent, and I would say that would be the case in normal times. I think that's even more exacerbated now because the Fed is squarely understanding that their mandate is full employment. We've been there, right. And price stability. We're not there with price stability and inflation's high. I think the Fed knows what they need to do. And I think they're more focused on tamping down and bringing down inflation, less so on the political side of things. And again, post midterm elections, we believe that there's a higher likelihood to have divided Congress. So you're not going to really have any legislation. You're just going to have a lot of rhetoric and it's going to be more like professional wrestling than it is really government legislation.

Amy: So you may, excuse me, you may both want to weigh in on this one. So we've talked about how if we were to slip into a recession, that it would be very short lived and very shallow in nature. This person is asking what data would make you concerned that a recession may not be short lived?

Phil: Yeah, I think there's a few things to watch. One, 70% of our economy is consumer, right? So, so, let's say some of the really tightness in the labor market loosens very quickly. Imagine those job openings going away very quickly. Unemployment rising, initial jobless claims—which is a weekly indicator that we watch skyrocketing—not rising modestly, as we've seen recently. Really skyrocketing. That could lead to protracted economic recession.

Brent: Yeah.

Phil: The other risk is something that we've seen out there is a repeat of the early 80s, sort of a double-dip scenario where we have a shallow recession. The Fed still can't get inflation under control. We have something deeper, further down the road. Too early to have real visibility into that. We don't even know if we're going to solve a recession issue in the next 12 to 18 months. But certainly something I think will be a topic in the financial press as we move over the next year.

Brent: Yeah, I mean, I think it's—well said, Phil. I mean, to me, it's inflation is high. At what rate will it moderate? None of us believe that we're going to—well, knock on wood—15%, right, it just mathematically to get there, it would be pretty tough to see. But if to Phil's point, the data has been coming up, right? If we don't get the rate of moderation, it's a timing game because 90% of Americans spend $0.99 of every dollar of monthly net income on stuff. Right, we talked about credit card debt starting to really pick up. Savings has come down materially, and they've been eating through some of that fiscal stimulus and some of that savings. So it's really a timing issue, right? Because to Phil's point, 69% is consumption, another 4.7 to 4.8% is housing—which we already talked about softening a little bit. So if that were the moderation we didn't see in the inflation side, we could potentially see a longer and protracted issue with consumers, conflate that or bring that together with some of the labor market potentially softening and hiring starting to come down. We don't believe corporations are going to unwind all the hard work that they did. It's so difficult to find people and hire them. We find it hard to believe that we're going to just see these mass layoffs—

Phil: Right.

Brent: —that are going to lead to an unwinding of a labor market. As long as consumers have stable jobs and have an income, we think that will be OK. But things along those lines, Amy, to where we see the labor market unraveling or inflation remain much higher and stickier for longer, could really feed back negatively into the consumer.

Amy: Brent and Phil, thank you both so much for your time and answering questions and sharing all of that information with us. I want to thank everyone for being with us today. Our next market update will be on August 31, which is not the same day as a Fed meeting. So more information coming out in the coming weeks on that. On behalf of all of us here First Citizens, I want to thank you all for trusting us, to bring you this information, to help you make your financial decisions. That's something that we never take for granted. We hope you have a great rest of the week, and we look forward to seeing you on our next webinar. Thanks, everyone.

Phil: Thank you.

The views expressed are those of the author(s) at the time of writing and are subject to change without notice. First Citizens does not assume any liability for losses that may result from the information in this piece. This is intended for general educational and informational purposes only and should not be viewed as investment advice or recommendation for a security, investment product or personal investment advice.

Your investments in securities, annuities and insurance are not insured by the FDIC or any other federal government agency and may lose value. They are not a deposit or other obligation of, or guaranteed by any bank or bank affiliate and are subject to investment risks, including possible loss of the principal amount invested. Past performance does not guarantee future results.

First Citizens Wealth Management is a registered trademark of First Citizens BancShares, Inc. First Citizens Wealth Management products and services are offered by First-Citizens Bank & Trust Company, Member FDIC; First Citizens Investor Services, Inc., Member FINRA/SIPC, an SEC-registered broker-dealer and investment advisor; and First Citizens Asset Management, Inc., an SEC-registered investment advisor.

Brokerage and investment advisory services are offered through First Citizens Investor Services, Inc., Member FINRA/SIPC. First Citizens Asset Management, Inc. provides investment advisory services.

Bank deposit products are offered by First Citizens Bank, Member FDIC.

Key Takeaways

The risk of a recession has risen, and it's now a coin flip as to whether we see a recession in the next 12 months. Since May, we've increased the probability of a recession from 45% to 50%. Unfortunately, neither a recession nor mid-cycle slowdown are easy periods for investors.

  • Bear case (50%): Recession
  • Base case (45%): Mid-cycle slowdown
  • Bull case (5%): Re-acceleration

If a recession does occur, there's a silver lining: Consumers and corporations are both strong. We believe a recession could be cyclical in nature—likely a shallower and shorter duration drawdown.


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First Citizens Wealth Management is a registered trademark of First Citizens BancShares, Inc. First Citizens Wealth Management products and services are offered by First-Citizens Bank & Trust Company, Member FDIC; First Citizens Investor Services, Inc., Member FINRA and SIPC, an SEC-registered broker-dealer and investment advisor; and First Citizens Asset Management, Inc., an SEC-registered investment advisor.

Brokerage and investment advisory services are offered through First Citizens Investor Services, Inc., Member FINRA and SIPC. First Citizens Asset Management, Inc. provides investment advisory services.

Bank deposit products are offered by First Citizens Bank, Member FDIC.