Planning · June 24, 2022

Making Sense Webinar: June Highlights

Brent Ciliano

CFA | SVP, Chief Investment Officer

Phillip Neuhart

SVP, Director of Economic and Market Research

Making Sense: June Highlights webinar replay

Amy: Hello, everyone, and 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 at First Citizens Bank, and while everyone’s signing in, I want to 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 ask a question during today's discussion, please use the Q&A or chat feature on the right-hand side of your screen. We do 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. If you have any questions or concerns about any of the information you hear today, please reach out to your First Citizens Partner. Brent with that, we're ready to go, so I will turn it over to you.

Brent: Great thank you, Amy, and good afternoon, everyone. I hope all of you are well. Phil, what an incredible start to the year that we've had. Rampant, multi-decade, high inflation, deep global supply chain issues, lots of stuff going on.

Phil: Absolutely.

Brent: Across the board, specifically a war on Ukraine, geopolitical turmoil, we've had issues with the Fed, change in monetary policy.

Phil: Supply chain.

Brent: Supply chain issues, the worst start to the year for equities since 1939. Worst start for bonds ever, just so a lot for us to unpack. So Phil and I are going to break the conversation down to two parts. First, I want to get into the economic side. Talk about growth. Talk about the labor market, consumer, the Fed and interest rates. Then we're going to talk about where do markets go from there? We had a special event that we did last Thursday as it relates to the markets where Phil and I got into a lot of detail as it relates to valuations where the markets are. If you haven't seen that, please go back and listen to that, but we are going to get deep here as well. So why don't we jump in, Amy?

Now let's talk about the economy and where we are. The Fed has moved pretty significantly. We are now in a new stage of this economic cycle, which is one of lower and slower growth. The shining star in our economy right now, Phil, is the labor market, right? The pandemic brought about the sharpest contraction the labor market in our history. We lost 22.4 million jobs in only two months, March and April 2020. Since then, we've recovered significantly. The unemployment rate hit 14.7%, now down to 3.6%. Incredible recovery. The Department of Labor came out at the end of April and said, we now have the fewest number of Americans claiming unemployment since the early seventies, so just an incredible turn. Despite that, we still have 10.9 million open jobs, so an incredibly tight labor market. So when we look at the next slide, Amy, and we're talking about wages and the consumer, average hourly earnings, Phil, has recovered very nicely from the pandemic low, and we've been clocking at about 5.2% in average hourly earnings and wages are growing nicely. But once you factor in the effects of inflation, wages are still growing at a negative rate, which is a problem. As you can see on the right, as savings rates have come down, we went from a high of 33.1%, we're now sitting at about 4.4%. Consumers are burning through those savings. We are starting to see consumer credit outstanding. And what we're looking at here on this chart is year over year changes. Consumer credit is starting to expand. The good news is when I looked at consumer credit as a percentage of GDP, Phil, we're still at very, very low levels, 30-year lows. So still a long way to go, but it's showing you the change in where we are as it relates to saving and spending habits.

Well, in the next slide, when we talk about the consumer and how the consumer's feeling on the left, we're looking at the University of Michigan Consumer Sentiment. And the last time we were on the WebEx, we were looking at the lowest level since 2011. Looking at the June data, we are now from a confidence perspective, at the lowest level ever recorded until this data goes back to the early 60s. So pretty significant change in sentiment. The interesting thing that was cited, three specific things, two you probably expect, one is much higher inflation, supply shortages. You go to Walmart. You go to Target. You can't find the things that you need. But the third thing that was cited in there and it’s been the last three or four quarters is discord in Washington, DC. Certainly with the midterm elections coming up a lot on people's minds. The good news is that has yet to feed back into spending. Certainly, we saw some soft retail sales lately. So spending on goods is starting to moderate and come down a little bit, but pick up in services, and we're looking at some of the data that will be coming out later in the month and hopefully spending overall remains intact. And remember, over 73% of US real GDP is the consumer. 69% is consumption with a 4.8% is housing. So as goes the consumer, as goes real GDP. When we think about where we are as it relates to inflation, and Phil, I know you're going to get into the details, everyone knows that inflation is 8.6%, CPI, we thought we had seen a peak back in March, wasn't the case. Core still sitting at about 6%, Producer Price Index at a ridiculously high level of 18.6. About 6 and change when I look at the core CPI. But it's not just the United States. When I look at the euro area or Japan, we have high inflation everywhere. So Phil, why don't you unpack a little bit of the details?

Phil: Yeah so if we look at the next slide, that 8.6%, what makes up that year-on-year gain, what are the components? So first, energy is about a quarter of the game, right? The issue is and in foods, what 16% of the gain the energy is, the issue is, is that about 75% of the 8.6% gain is not energy, right, shelter, 22%. So the concern is that stickier types of inflation are starting to enter into the economy. That's a major concern for investors in the Federal Reserve just to hammer home that point if you flip to the next slide. The gold area in this slide is the percentage of components within the Consumer Price Index that are seeing inflation north of 5%. So you want to see this number low, you could see historically it was now it's about 2/3 of components, right? So it is broader now. This is no longer transitory. This is no longer things like commodity prices that tend to move up and down. It is really expanding into stickier types of inflation. And that's a concern, of course, as we move forward and why the Fed hiked 75 basis points last week. So this is beginning to feed into to the markets and what companies are saying. So here a partner, they have a transcript analyzer, so looking S&P 500 companies, what are they saying in their earnings reports? You can see mentions of inflation and higher costs in the top here have expanded dramatically, as you'd expect, and really are at an all-time highs at least for in recent decades. Now, shortages at the bottom, we see some improvement still high, but maybe there's some glimmers of hope there on the shortages front, which down the road might help on the inflation.

Brent: Absolutely, feeding back into the demand impulse shortages loosening up, feeding back into potentially discounts for clients and overall reduction in demand so…

Phil: That's right. So again, might impact company margins as we move forward. So let's look back at expectations on the next slide. So in terms of surveying consumers, this data is lagged, but it directionally gives you an idea. The Fed surveys people and says, what is your expected one year and three years ahead inflation expectations? One year very elevated, much higher than three-year, which is good news, but the issue is those three-year inflation expectations have started to accelerate again. That is a problem and again, why markets have reacted the way they have. So if we look at what are experts saying in terms of the level of year-on-year Consumer Price Index growth. Not too surprisingly, very high in the near term, the gold bars here, it is falling. The issue is the rate of that fall is worsening. So when we met in May, that fourth quarter of 2020 levels, 5.9%, right, now, that is 6.5%. So in one month, we went up quite a bit. That's the concern.

Brent: Yeah, the rate of moderation for certain is certain.

Phil: That's right. That's right. So if we flip ahead to what we were seeing from the Federal Reserve, so all this inflation, the Fed's being forced to act, we are looking here at expectations in the marketplace in terms of levels of the Fed Funds Rate at the end of this year. The x-axis here is the level of the Fed Funds Rate. So when you see 350 to 375 basis points, that's 3.5% to 3.75%. And then the likelihood is the y-axis. So it's the market telling us is that the Fed Funds Rate at the end of this year is going to be something like 3.5 to 4%. Right now, the Fed Funds Rate is 1.5 to 1.75%, so they're going to continue to hike pretty rapidly, according to the market. What's interesting is when you look further out one year out, expectations are still at about this level, which means the market really thinks a lot of the Fed's work is going to happen this year has been pulled forward to this year. Remember, as of late last year, the expectations were what, for the Fed to move once, twice, maybe not at all and look how many hikes we've had.

Brent: And the variability, I mean, we were literally terminal value at almost 5% a week ago. So, so much variability in how far and how fast the Fed will be going.

Phil: That's right. And when we look at interest rates on the following slide, markets had to catch up with this expectation from the Fed. So the left side, we're looking at Treasury yields for the two year and 10-year Treasury real skyrocketing, particularly in the two-year space. As you could see here, we've seen some draw down in recent days, but 3.3%, 3.2% really high levels. We'll talk more about broader fixed income markets in a moment, but we have seen a real catch up in the marketplace. This, of course, impacts everything from mortgage rates to lending rates, et cetera. Additionally, the yield curve is flat. What do you mean by that? On the right side, the spread between the 10-year yield of the two-year yield has narrowed dramatically. In fact, it's slightly inverted earlier this year. This is indicative of slowing growth in the economic marketplace, which we do expect. So what are we seeing in terms of are we going to recession or not? This is something we outline each webinar. I want to give you an update. So first, the US economy is slowing. Inflationary pressures remain high. That is very clear to us and market participants. In our view, the risk of recession has risen. We do not have a recession in our one your base case, but is a close call. So let's talk about that in detail. We have here a bear case, a base case and a bull case. The bear case is recession. We have a 45% probability of that. When we met in May, that was 40%, and last week we updated that to 45%. So certainly a material probability, just not quite the base case. The base case is mid-cycle slowdown, again, mid-cycle slowdown is not fun. Think about 2011. Think about 2018. It's not as if those are easy periods to operate, but a but not quite a recession.

Brent: Yeah, if there's a silver lining, Phil, to any of this, it's certainly a recession, if it's hard to find a silver lining inside of a recession, but if in fact we're wrong and we do find ourselves in a recession, the good news is that the consumer and corporations are in the best shape that they've been in more than 50 years. So we think that if that were to happen, that this recession would be much shallower and shorter duration than previous recessions.

Phil: And one thing if we were to have a recession that's different from recent cycles is the speed at which the recession would be beginning after the first Fed rate hike. So you think about the 90s, the Fed first hiked in 1994. That recession, the next recession was 2001. Right? Yeah, yeah. You're talking the next cycle, Fed started hiking 2004 for that recession, as we all know, started December of ‘07 really accelerated 2008 years later. Last cycle, 2015 the Fed started hiking, we had a recession 2020 and that was the pandemic. Yeah, so, so, usually it's multiple years. This would be a different type of event.

Brent: Absolutely so why don't we transition now? And let's talk about where do markets go from here? And as I said at the beginning, we've had very, very extreme volatility in both equity and fixed income markets. So let's kind of get into the details of that and let’s go to the first slide, Amy. But we, as we talked about on the WebEx that we did last Thursday and on the one that we did at the end of May, the S&P 500 is now in a bear market. And to update this on the fly through last night, the 21st, we are down a little bit over 20%. So let's kind get behind the details because I can see some of the questions coming in already Phil, and the questions that we got before the WebEx started is, well, how much further do we go down? What is the level that might support the markets and how much further will we fall? So why don't we start and take this from a fundamental level and look at valuations? Let's look at the graph on the right-hand side here. And despite the market selling down over 20%, Phil, earnings are positive and have grown 6.4% year to date. But when I look at that blue line on the right, the market's multiple has contracted 30% and just to make sure that we're all saying the same and understanding the same thing, the market's multiple or PE ratio is nothing more than what investors are willing to pay for a dollar of earnings. So the component of the S&P 500 is earnings per share times what you're willing to pay for a dollar of those earnings gets you the S&P 500 price, and to see that we've already contracted 30% is way beyond what we've historically seen at this part of the hiking.

Phil: So in that ratio, in this case, earnings expectations have gone up, price has gone down, so multiples gone down even more because of that earnings.

Brent: So before we get into talking more about where the floor might be potentially under the market, let's talk a little bit about where our corporate earnings and profitability is and for 2022, despite all of this inflation and geopolitical concerns, consensus expectations on earnings have actually gone up, not down. We came into the year expecting 9.4% growth. We were there and March 31st, we had gotten to 10.2% at the end of May. We are now up to 10.4% full year earnings growth year over year in 2022. So what we are seeing as you come down and you look at the second quarter earnings, expectations for growth are falling. In the bottom right chart you can see analysts' expectations are starting to fall for not only the second quarter, but the remainder of the year. So some of that slowdown high inflation, the global supply chain issues. Analysts are starting to revise down those earnings, so we don't see that softening, Phil, in 2022. We're seeing that potential softening as we get into 2023.

Phil: And company analysts are notoriously late in terms of revisions because they're focused on the trees, not the forest, and they are starting to finally, catch up, and like you said, probably start to show up more than 2023 numbers.

Brent: Absolutely so let's get to the next slide, Amy. Let's talk about where the multiple has contracted historically. I know this is a little bit busy slide, but what we're looking at here is all Fed rate hiking cycles post 1970. The Black line in the middle is zero months, the start of the hiking cycle. And as you kind of go to the right there, you can see three different lines. The dark blue line is the average multiple contraction of all hiking cycles post 1970. Light blue line is post 1990 and the orange line, which I think is more indicative of where we are, are the three worst environments where we had very, very high inflation, high-rate hiking cycles, 1972, 1977 and 1980. And what you can see the average of all cycles, the multiple contracted on average about 10 percent, but that was 12 to 24 months after not in the first zero to six months. First zero to six months was basically flat from a multiple perspective. The orange line might give us a better indication of what we might see this cycle, which of those more extreme periods. That multiple contraction saw 15% to 20% contraction 12 to 24 months post. As I just said, we've already contracted 30 percent, so maybe the market is overdone. Self-first, think later. But let's talk about, as Amy advances to the next slide, where we think maybe that floor could potentially be. So what we're looking at here is the last decade of where the market has found a floor in valuations. And when you look at the 5 other bottoms that we've seen over the last decade when markets sold off, the average of those five that market multiple hit about 15 times. The worst was in the pandemic, where we fell 14 times forward earnings. Right now, I'm going to update this on the fly. We are sitting right now as of last night, the 21st at 15.93 times. So if the market were to fall back to the average, that would imply an S&P 500 level of 35.45 or about 6% off of where we are today. If we fell to the worst level that we saw over the last decade, which was 14 times, that would imply a level of about 33.09, which would be about 12% additional fall from where we are right now. To put into perspective, when I get rid of the top 10 stocks in the S&P 500, which is skewing average, the S&P 500 or the 490 stocks is trading at 13.13 times right now. So a lot of moving parts, but maybe there are some levels underneath the market.

Phil: That's right. And when you think about that multiple and how it interacts with the economy if we flip ahead. One thing we point out a lot is that markets and the economy do not move in lockstep. They're obviously related, right? Markets sell off in a recession, but they are not necessarily in lockstep in terms of timing. So here we're showing the Consumer Stress Indicator. This looks at everything like food at home. What are prices for food? What mortgage rates, gasoline prices? Not too surprisingly, the Consumer Stress Indicator’s high right now. Consumers are feeling stress, so let's look at what does that mean for the market? The lower right if you look at forward 12-month S&P 500 performance based on various levels of the stress indicator, looking at the highest level where we are today, the current reading indicates forward return that's pretty dramatically high. Why is that? Think about 2020 when at the depths of the pandemic was really when the market bottomed.

Brent: Yeah.

Phil: So let's look ahead and spend some time on the table. We've shown before, but want to dwell on for a moment here. So first, here we are looking at material drawdowns 10% or higher in periods since 1950 and we've broken it out into recession on the left side and non-recession on the right side. So you can see different periods, for example, a recent one on the left side. 2020 the pandemic, you could see the start date, the end date months of the peak to trough decline in the market, right,1.1 months, that was very short. The decline was 35%. So if your eye moves to the bottom on average versus median months to peak, peak to trough are eight or nine months right, you could see a lot of variation there, right? There's one month I see 30 months. They can vary, but on average nine to eight months. We're about six months in now. The percent decline 27, 20% average versus median at the bottom there. We're north of 20% now we're kind of between the average and median. Again, a lot of variation. Everything from negative 13.6% to negative 56% but what we want you to focus on are the right two, the right two columns. One year after that low, you tend to see pretty dramatic rallies, right? And when you look at the percent recovery of previous high, so you have that previous high. How much of it have you gotten back a year later? On average and median, you've gotten back over 100% of the decline. There are exceptions to that, particularly structural versus cyclical. We think this is a little bit more cyclical when you think about something like the Great Financial Crisis, that was a structural drawdown.

Brent: Yeah, yeah. I think it's really important now. It's what you said. So can the market go lower? Absolutely anything can happen. But your point when I look at those big ones, 57% the 49%, the 44% percent, you are talking about fundamental structural issues. Years and years of massive build up that unwind. That's not really what we're talking about here. We are talking about a cyclical bear market that we believe that we're in right now, which is symptomatic of, you know, rising rates to cool rapid growth and potentially periods of higher inflation.

Phil: And just to cover quickly, non-recessionary, which may be where we are today, you can see the peak to trough decline tends to be a bit shorter. That makes sense to me, at least, but the percent decline is pretty similar. 23% on average, 22% on median, about where we are today, but not that different from a recessionary period. So basically, what the market is saying is recession or not, you do get market corrections within mid-cycle slowdowns and recessionary environments.

Brent: Yeah and I thought what was most interesting when we put this data together, a lot of clients that I've talked to, prospects said, well, you know, it's really volatile. Maybe it'll sell off more. Maybe I'll just take a little bit of cash and put it on the sideline and wait for things to settle down and then get back in. Once I've seen things to, things come back up. When we put together this data, almost 50% of the total recovery occurred in the first three months after the bottom. It is, first of all, nearly impossible to time when you hit the bottom and missing that first three months after the market is bottomed out. You can significantly impair your wealth if you just step out of the market hoping to get rid of some of the downside and catch at least some of the upside.

Phil: That's right. So that's equities. Let's talk fixed income for a moment here. So as Brent alluded to, we've had an unbelievable sort of 100-year event in terms of fixed income in terms of how bad the start of the year has been. That's the implications for our investors. And for investors widely. If you have a 60-40 portfolio, you're conditioned to think when equities sell off, bonds rally, right, you have that balance that offset, that's not been the case this year. Bloomberg US Treasury index down 10%. The US Aggregate Bond Index on the right side, they're down 11.5%. So really historic type drawdowns within fixed income. Now the good news in fixed income prices go down, yield goes up. So we are seeing actual potential for excess return within fixed income going forward. Just looking at that US Ag Index at the end of last year, 1.75% yield, today, 3.93 yield. So it's more than doubled. So we are seeing we're seeing interest from clients. There is an actual yield in the fixed income marketplace, something we've not had for a number of years.

Brent: Yeah, absolutely. And it's across the entire curve, as you mentioned earlier, whether your investment policy statement has short on the curve or intermediate or long term, you can get compensated pretty nicely. And it's silver lining from all of this is that we've been talking about a lower for longer environment and how a material part of the client's portfolio might not be able to do the heavy lifting that it had done in the past. How things have changed in such a short period of time. But to your point, forward expected returns are not too dissimilar to spot yields. So when we're looking at yields in that 3.5 to 5% bodes well for future expected returns for that part of a client's portfolio.

Phil: That's right, so let's talk about market timing, which you mentioned a moment ago, Brent. So what we do believe timing markets can prove costly. So what are what are we looking at here? This is S&P 500 Compound Annual Growth Rate from 1995 to 2022, thousands of days. Right if you were fully invested that whole period, the S&P 500 return on an annualized basis is 8.4% really strong return when you consider have the tech bubble in there. The Great Financial Crisis, the pandemic, 8.4%. If you missed just the five best days, the five best days, out of those thousands of days, that return falls to 6.6%. That's 22% less. You missed the best 10 days, that return falls to 5.3%, that is 36% less.

Brent: I mean, that's missing 10 days out of 6,600. It's incredible.

Phil: It's unbelievable. The reason is when markets are volatile, you get big down days, but big up days as well. And to that point, on the right side here, nearly half of the S&P 500 index's strongest days occurred during a bear market.

Brent: When you never want to be an investor.

Phil: 28% of the market's best days take place in the first two months of a bull market when, again, because of timing, you don't know you're in a bull market yet the first two months. So that's over 3/4 of days happened in bear markets and soon after.

Brent: So let's bring this home, Phil, and let's get to our bottom-line views, so let's start first where consensus is, I'm going to give you two from two points of view. What we're looking at here on the screen is the bottom up, right, analyst looking at individual stocks and the implied expected return for the S&P 500 months forward from today. And you can see still almost 5,012 months forward, that's a 37% return from June 16’s close of 3,666, which, by the way, has been the low year today. Where are we right now? We're revised our price target down from where we were back at the May meeting, we had 4,600. We brought that down to 4,350, why? The two components that we've been looking at are earnings growth and then multiple contraction. We've been saying that since December 15th of last year, we're looking at 8% to 10% earnings growth this year, right? But what we're now looking where our expectations have changed, which is that multiple contraction, right, that orange line that we showed everyone that 15% to 20% contraction, we think the market might come back up from a 30% contraction to that 15 20%, which would imply an 8.5% decline year over year from 4,766 down to 4,350. And again, while 4,350 is certainly down in our expectations given where we are right now, that that's a material increase from where the markets are right now today. Lastly, when we look at where the markets could go over this full cycle, we still believe that the S&P 500 can reach 5,000 or higher towards the end of 2023 in the first half of 2024 likely by then, as you highlighted, you know, inflation would likely significantly moderate by then. The hiking pressures and the hawkish tone from the Fed, we think, will moderate, will be post midterm elections and we can certainly I can see some questions coming in on the elections. Maybe we'll cover that a little bit. You put all that together, earnings expectations about $271 per share, which is where expectations are right now, that 18.5 times that you see in that last bullet, that is the long-term average when inflation moderates down to that 2 to 3% range. So if I take the historical average of 18.5 times to where analyst expectations now are at $271 per share, that gets you about 5,000. As you said nicely, Phil, so anything can change. The multiple can stay low. Analysts expectations, earnings and corporate earnings can be lower. But by and large, where we think right now, we think that there's higher highs in the S&P 500's future as we look out over the next couple of years. So Amy, I see we have an awful lot of questions that I love to get to some of them because I see some really great ones up there. Why don't we turn to questions?

Amy: Yeah, thank you both for all that information and that deep dive into the markets and the economy, we do have a number of questions. I've got a couple here around positioning, let's start there, Brent, if you don't mind, the big question for people is where to invest now are stocks, bonds, cash, real estate, hide it under a mattress. What should people be thinking?

Brent: Yes, not under a mattress. No matter what financial position you're in, that doesn't have a good return on investment. What I will say is, let's just start with the fundamental basics of fact. The equity markets have priced themselves 22% lower, right? Fixed income has seen its worst bear market in 100 years. So where financial asset pricing is today versus where it was three months ago, six months ago has significantly changed. Lower prices imply higher expected returns, so that's good for both stocks and bonds. So let's break it down Amy, into the two components.

Let's start first with equities. First, we have, I’ll talk positioning where we're seeing things overweight to US stocks versus international stocks down in cap, from large cap to mid and small cap as the cycle is fundamentally changing. We had been underweight international and continue to be underweight international. As valuations are changing, international markets are starting to look attractive. I think there's a little bit of time before we get there, but it's starting to look attractive from a relative valuation perspective. But again, down in cap, from large to mid and small in the portfolio, we look three years ahead, not a week, a quarter. We do believe in an economic slowdown where cash flows start to decelerate. Revenue starts to decelerate.

Earnings are harder to come by. Growth stocks tend to do better in those environments, and it's hard to see value stocks doing what they're doing and underperform for a long period of time have had their time in the sun. We think that cycle is going to change as we get longer and looking out three years, we do see growth stocks outperforming value stocks hasn't happened yet, but we do see that turn the cycle. All the fixed income side, as you mentioned, really nicely Phil, no matter where you are, you're getting attractive yields. And we think that that's going to continue for a bit.

Certainly, investment grade bonds, attractive yields, core fixed income, now sitting at a yield of about four percent, much more attractive than when it was 1.75 at the start of the year. So both equities in fixed income markets look attractive, Amy, and it's due to the discounted pricing.

Amy: So Brent, we talked about this a little bit already, but just to hammer the point home because I'm still seeing a couple of questions on it. When does the downturn end and where are we going from here?

Brent: Yeah, it's a great question. I think Phil and I both prefer not to think about it in terms of days, weeks or months because time is, is, is tough and it's fleeting. We try and look at it at price and level. And as Phil said, very nicely, we're already at negative 22%, the average and median, whether it was a recession or non-recession is in spitting distance of that, right? Could it get worse? Absolutely, right? But we had many, many examples to where it basically stopped here, or it wasn't as bad.

What I think is most important is when we kind of look at that slide on valuation when we talked about the valuation floors, right? If we got back to the average valuation for over the last decade, which is about 15 times, that implies a potential floor at 3,545. If it got really bad and got to the worst forward multiple that we saw in the pandemic, which was 14 times, that would imply an S&P 500 level, about 3,309. That's not 30% down from here. That's only 6% down if it's the average or 12% worse from here. If we got to the worst example. Again, anything can happen. But we're not, in our opinion that far from potentially where the bottom could be. Much can change.

Amy: Brent, I have a couple of questions here, as you alluded to earlier, a couple we received earlier on around the November midterm elections and what we may be doing to prepare for any kind of political instability that comes from that.

Brent: Yeah, so let me, I think that's a really important question because I, Phil and I have gotten a lot of those questions and we've been doing some client events recently. So I'm just going to tell you where consensus is, right? Right now, basically, all Democratic government. The Republicans need only five seats to swing the house. The current expectations are that the Republicans will take anywhere between 65 to 75 seats post the midterm elections, right? So if that were to happen, you then have divided Congress. When I look at market outcomes across any stratification of government, the best combination of government related to market prices has been Democratic president Republican House, Democratic senate, right? Divided Congress gives market a view that nothing will happen or very little will happen. It'll just be a lot of rhetoric and talking, not a lot of fundamental action. Certainly anything can change right now. The Senate is about a jump ball, and we don't know where that is. But I think the one thing and we've covered this on previous webinars is that the S&P 500's return post midterm elections has been positive 100% of observations since 1950 with an average return of 15.1%. So I would take the other side of that question saying that certainly anything can happen in elections. But I think we're trending, at least from a consensus perspective, more towards stability and action in government, not instability.

Amy: Thanks, Brent. We have a question here that's really interesting, so we talk a lot about historical references and what we're seeing with markets and the economy. I'm seeing a question here asking if the current financial environment is unprecedented and if so, are examples from the past really relevant.

Phil: Yeah, it's a great question. Look, history doesn't repeat itself, but it does rhyme. And what we're seeing today isn't completely unprecedented? There's never a perfect example in the past, no matter what you're seeing, but look in an inflationary environment with lower growth. See the 1970s. See the early 80s. Now, a lot has changed since then. Think about productivity in our economy. Think about it being a consumer led economy. Think about monetary policy. So again, there's no easy, direct correlation. If there was, the playbook would be very easy, and markets would have already priced it. So it's a great question. Does not mean you have clear answers, but I do think history can inform what we're seeing. So when we talk about troughs and multiple, I think it's worthwhile to look in the past when we talk about what markets can do in recession and non-recessionary periods, it's worth looking into the past. But look, every drawdown is created differently, right? Many of them become forgettable very quickly. Remember, the market sold off almost 20% at the end of 2018. That was a distant memory by back half of 2019. But it happened, right? So the answer is we do think historical context matters, but you cannot take it as a clean script to what's going to happen with precision.

Brent: Yeah, and we've looked into this, Phil. And so the pieces that we look to put out the term unprecedented or unprecedented environment, we look at the count and how often it was mentioned in the financial news media, in the news media, in 2000 and 2002, ‘07 to ’09. And in the pandemic, when it was 100 years since we'd seen anything like it, the term gets thrown around a lot. But like you said, history tends to rhyme. And we throw that out quite a lot. And it doesn't mean that human behavior doesn't replicate genetically preprogrammed to do certain things over and over. I think when we talk about environments, we go back to the 1980s.Iinflation averaged 5.3% for the entire decade, the S&P 500 averaged 17% for the entire decade. Just because you have high inflation and things could be different doesn't necessarily portend poor equity returns or poor fixed income returns. They can coexist together.

Amy: So, Brent, we talked a little bit about timing the markets and how you feel about that. I have a question here about if I have a significant amount of cash on hand and it's earmarked for long term investment. Should I go all in now or deploy it over a systematic timeline?

Brent: Yeah, I'll chime in real quick and then you can run with it, Phil. Right, so look. Dollar cost averaging throughout one's entire life when you're accumulating assets is an incredibly thoughtful strategy, right? You know, the academic side of it, whether you basically do lump sum or DCA or dollar cost averaging, you know, lump sum tends to work better than DCA over the long term. But I would argue investing constantly lends itself to better outcomes and higher accretion of wealth. So if we do have clients that are in the accumulation phase or have extra cash that is absolutely earmarked to longer term investing. Dollar cost averaging can make an awful lot of sense. And I think Phil, to what you recover.

Phil: Yeah and you know, in terms of dealing with clients, when I think about the market today, particularly equity markets, I think what we're referring to. Look, the S&P 500, you buy intraday today, it's trading at 21% year to date discount. If you were truly a long-term investor, which is really your money that should be in equities or long term, you're buying something on a 21% discount. Could it fall further? Absolutely, but in the long term, buying something a fifth lower than it was year to date is not a bad entry point.

Brent: Yeah, and same thing for fixed income. If you go back and look through the data and say, hey, I had an opportunity to get into fixed income at the worst level in 100 years, to some degree, common sense would dictate, well, what's the US government's going out of business? And we have Armageddon, and a meteor hits us like dinosaurs. You would think that on a longer-term basis might be a good entry point for fixed income and equities.

Amy: So Brent, I'm sorry, Phil, we've got an econ question here in response to the Fed, it looks like we're seeing a large jump in mortgage rates just in the past week. Do you think that's going to continue to rise and what does that mean for the housing market?

Phil: You know, so let's first talk about what it means for the housing market, then can continue. So in terms of the housing market, affordability is just much lower now than it was 12 to 18 months ago. And there's two main variables there. One price appreciation, right? It varies, but nationally we're at 20% year on year price appreciation. Two, mortgage rates. So you look at the cost of paying your monthly mortgage is dramatically higher than it was not that long ago. And we're starting to see real estate indicators slow down, whether that be new home sales, existing home sales, housing starts. Now, supplies are still very tight and it's very geographically specific, does not mean things are turning over tomorrow, but we're starting to see a bit of a slowdown, which makes some sense. Now in terms of mortgage rates, the dramatic rise, mortgage rates tend to be highly correlated with longer term US treasuries. So when you look at something like the 10 year or the 30-year moving up very dramatically this year, mortgage rates are going to move with that. So it's really a question of where do rates go? Clearly, when you look at Treasury yields, a lot is already in the price. It does not mean they can go higher, right? But a lot is in the price. So where mortgage rates go tomorrow, hard to tell with any real conviction. There's bias to the upside, for sure. But certainly a lot of the move is probably at this point in the price with Treasury yields and thereby in the price with mortgage rates.

Brent: I think what you said was quite apropos. I mean, to me, it's the cost of homeownership. So when you look at the data, the average home price cost is $505,000 now, right? You had almost a doubling of mortgage rates. You geometrically linked those two together. You have a year over year increase in homeownership, that's up 95%. That's got a bite at some point in time. Now, like you said, regionally specific, right? What's going on here? It might be a little bit different than where it is nationally.

Phil: Right, sure.

Amy: So as you both know; we use the S&P 500 as a big part of our metrics. I've got a question here about the other indices around the Dow and the NASDAQ and where we think those might be going as well, if you'd like to speak to it.

Brent: Yeah well, we've certainly seen a significant contraction in the NASDAQ, right? A lot of the growth-oriented companies, tech companies, consumer discretionary has seen significant price discounts. Right?

Phil: Right.

Brent: And then tech got hit probably the hardest right. We've seen a total of almost 60% of US GDP equivalent evaporated in equity markets across all indices Amy, year to date. That is one of the largest evaporations of market capitalization that we've seen in decades. So we've seen a very, very fast contraction within the S&P 500 of the Dow or the NASDAQ. Again, the more growth-oriented sectors, we've seen more significant compression, which then portends potentially higher forward returns. But again, we're going to have to see how high rates actually go because remember, growth companies and technology companies have much longer duration cash flows and earnings. So higher interest rates tend to affect those cash flows and earnings more severely because of the longer duration when you're discounting that back to present value.

Phil: Right. Often when we're talking about NASDAQ versus S&P, if you really talk about sector differences, right? So if you look at the S&P sectors, the best performing sectors, year to date, energy, well, not surprising, right? Look at what's happening with crude oil utilities, consumer staples and health care. All defensive sectors at the bottom. Consumer discretionary, communication services and tech. So when you look at the bottom and it's internet related companies like communication services tech companies, well, of course, that impacts the NASDAQ more. Really, the question is, when do we start to see sector rotation? And that's when you see rotation of those industry levels, right, right. The index…

Brent: It's crazy. The energy stocks were up at one point in time, 62% year to date. They're now up 33. We, we lost 21% in five days yesterday in energy stocks. There's a lot of volatility going on underneath the hood. Again, that's why we don't forecast next week, the next month or the next quarter, because it's nearly impossible. We need to look out over that three-year horizon and get the relative positioning of these things right. Not just sort of that flash in the pan. Commodities have significantly come back down, and the Bloomberg Commodity spot index has come down significantly. Energy stocks have come back a lot of movement underneath the hood.

Amy: Brent, Phil, thank you both for all of that information and answering questions for us. We'll go ahead and wrap up today. I want to thank everyone for being on the webinar today. If your question wasn't answered, please reach out to your First Citizens partner. Our next market update is Wednesday, July 27th at noon eastern, and we'll be sharing details with you in the coming weeks. We'll also continue to bring you up to date information as the world turns and markets and the economy progress. On behalf of all of us here First Citizens, I want to thank you for trusting us to bring you this information to help you with 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.

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, but we do not have a recession as our 1-year base case. Since May, we've increased the probability of a recession from 40% to 45%. Our base case remains that we'll have a mid-cycle slowdown, but not quite to recessionary levels. Unfortunately, neither a recession nor mid-cycle slowdown are easy periods for investors.

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

However, if we're wrong and a recession does occur, there's a silver lining: consumers and corporations are both strong. We believe a recession would 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.