Market Outlook

Making Sense

Market Update | February 2026

Recorded on February 25, 2026

Amy: Hi, I'm Amy Thomas. I'm a strategist here at First Citizens Bank. Today is Wednesday, February 25, 2026, and I want to welcome you to our monthly Making Sense market update series. Today, Phil Neuhart and Blake Taylor, members of our market and economic research team, will take a deep dive into what's happening in the markets and the economy.

As always, the information you're about to hear are the views and opinions of only the authors at the time of recording and should be considered for educational purposes only. This should not be considered as tax, legal or investment advice.

Phil: Thank you everyone for joining. And Blake, thank you for joining with Brent on the road today. Really excited to present our most up-to-date economic and market views with you today. So what are we going to cover?

One, the economy as always. We want to dig into growth expectations, the labor market, some policy developments which have really heated up in recent weeks, and take a moment to dig into the US housing market as well. From a market perspective, we want to spend some time on equity markets, artificial intelligence, which is really the topic on everyone's mind today, and spend some time on fixed income also. So, with that, Blake, let's jump right into the economic update.

Blake: Yeah, the economy's on solid footing. Real GDP growth has been growing at or above a trend pace for the last few quarters. And just looking back 90 days, which is what these gold triangles are here in the forecasted section of the chart, things are looking better compared to 3 months ago. So forecasts have been increasing their expectations for Real GDP growth, inflation-adjusted, in the coming quarters.

However, I don't know about you, but I live in a nominal world. I buy my groceries, I receive my paychecks, I make my investments in nominal dollars, not in inflation-adjusted dollars. And what this chart is showing here in the light blue line at the top of the chart is nominal GDP growth. How fast is the economy expanding without adjusting for inflation?

And the answer is really the last 5 years, the economy in nominal terms has been booming. So inflation is supposed to run at about a 2% trend pace. Real GDP growth also runs supposedly at about a 2% pace. We've been running at above a 5% pace on average for the last few years, so the economy really has been booming.

And then what else happens in nominal dollars? Corporate revenues and profits are quoted and experienced of course in nominal terms. So the economy has been warm, maybe even hot, and that's been quite good at least for anybody who has, whose wages have been able to keep up with inflation. Where things might get stickier going forward—is this slightly above-trend pace going to be able to continue as-is or are we going to maybe run the risk of creeping up too high again?

And what makes up for the vast majority of spending or of GDP growth is household spending. And although in the last few months household spending appears to have decelerated, it has slowed to still a very solid, decent, respectable pace. So adjusting for inflation, household spending growth is running about a 1.7% pace, but again in nominal terms, closer, rounding up to a 5% pace. This series can be a little jagged and it was showing a little bit more strength towards the end of last year, but to be very clear, 1.7% inflation-adjusted pace is at or above trend. So overall, the economy is starting off 2026 with very solid footing.

Phil: And you can't really think about consumer spending and how important that is without thinking about the labor market. And a topic we've touched a lot on over the last couple of years has been the top heaviness of different things. Right? One, the consumer.

Another is the S&P 500. The biggest companies have just gotten bigger. You do see this playing out in the labor market as well. If you look since January of 2024, where has the real growth in employment come from? It's come from larger companies, companies with over 500 employees.

Looking at smaller companies, whether that's 1 to 250 employees, which is the blue line, just very slight growth, and then you see 250 to 500 employees actually declining. So it kind of rhymes with what we're seeing even in public markets that the big feel like they are getting bigger. That may have some societal impacts, but this is really the breakdown. The biggest companies have benefited the most. You can see, of course, that that leg higher has even increased since the Liberation Day tariffs of about a year ago.

Blake: Yeah. Big companies are able to handle some of the shocks that have been thrown at businesses in the last few years, maybe with more ease than some of the medium and smaller ones. Inflation, tariffs, the list goes on.

Phil: That's right. And then looking at the picture as a whole. And here we're just showing payroll job growth, 12-month rolling sum. So, in other words, just kind of over the trailing 1 year, you've seen the pace of job growth has decelerated quite a bit from the rapid growth of 2021, 2022. That should be expected, by the way.

We were seeing a major bounce back from the pandemic, but it has really slowed it. And something that's maybe even more interesting is the gold bars here, which is if you look at recent periods, health care has really accounted for almost all of the job growth. Few things to think about here. One, there are some demographic reasons for this. We have an aging population. The baby boom is entering the heavier healthcare years. Right? And we are a service economy, which has been true for decades.

But I think this really highlights that we're a service economy and healthcare is the biggest part of that. We would like to see more sectors participating in this, to be clear. This is not necessarily a good thing, but it does also show how prominent healthcare is in our economy. If that were to weaken, that is a real risk to the labor market.

Blake: Yeah, and I think it's helpful to think about where we are today by comparing to the solid economic years of maybe 2017 to 2019 before the pandemic. And as you can see in those prior years, the economy was printing about 2.5 million jobs a year, and now we're really slowed to a stall speed of just about 300,000 jobs created in the last 12 months.

The other half of the economy that we can look at, aside from the labor market, maybe is prices. And as is becoming abundantly clear, for the last 5, 6 years, inflation has run above target.

Inflation is supposed to be 2% as prescribed by the Federal Reserve. That's the target rate that they are trying to deliver for the American public. Inflation's been running at 3%. And as you can see, even after coming down from the massive surges in inflation in 2021 through 2022, rather than coming all the way down to 2%, that last mile down to 2% has proven to be the hardest.

And in fact, forecasters, whether you look at the private sector, look at policymakers, or you just look into the markets and you look at inflation swap rates, nobody is expecting inflation to return all the way back to 2% anytime in the near future. However, it is close. So I think a lot of investors and policymakers have just gotten used to inflation running a little bit above target.

Just like so many things in markets, it's really unreasonable to expect it to hit right at the number that you want. So is 2.5% close enough to 2%? Maybe. Is 3% close enough to 2%? Probably not. But the reality is we are still running with above-target inflation. There are still risks to the upside that a lot of policymakers are starting to talk about more just in recent weeks.

We might not have seen all the tariffs pass through into consumer prices that might ramp up in 2026. We might see more labor supply constraints, but at the same time, predicting inflation can be a fool's errand. And just on the other side, we see housing costs probably driving some disinflation in the economy. But where we are is where we've been for a few years, which is inflation just running slightly above target.

And what does that mean for the Fed outlook? The Fed is seen as solidly on hold for at least the next few months. Markets are pricing a couple 25-basis-point interest rate cuts this year. That's of course a probability-weighted average. That's not every investor saying we are going to cut twice. That is probably more a reflection of seeing the Fed's mostly on hold, maybe with some downside risk. So a slightly more likely scenario that the Fed cuts rather than hikes.

This has been very fluid. Just in the last couple weeks, as I said, policymakers have come out and said maybe we're a little bit more concerned about the inflation outlook than we have been in the past. And then of course there's a lot of things changing at the Fed this year. There's been a new chairman that's been appointed by the White House. He still needs to go through the Senate confirmation process, and we're not sure how that's going to affect the Fed. But the point is, Fed's seen as on hold for now.

Phil: Yeah. It feels like the Fed, if there are cuts, we're talking back half. And the Fed is having a new chair. But also, this is a data-dependent Fed, right? And if inflation is not cooperating or on the other side, if the labor market deteriorates, we're going to see Fed action beyond what futures are pricing today.

Blake: Absolutely. And going to the policy outlook here, there's been considerable noise for the last year on the international trade and tariff outlook, of course.

As everyone saw on Friday, the Supreme Court gave its long-awaited ruling on its opinion of these emergency tariffs that the White House enacted last April. This is what became known as the reciprocal tariffs that the White House used in international economic emergencies power to implement those tariffs.

Supreme Court decided that that was not appropriate, that was not a legal action, so they have ruled, have invalidated about 60% of the maybe $300 billion in tariffs that have been collected the last 12 months. The White House came back with a widely expected response using a separate executive authority to implement a 15% tariff rate across the board. Still waiting to see how all this settles out. The US trade representative was just giving comments earlier about saying we're still working on setting the various tariff rates for different countries.

But what a lot of people are asking is, "What's going to happen to the $170 billion that was paid between Q1 of last year and last week under these tariffs that were invalidated?" And most people are expecting about that $170 billion dollars will be paid back to companies over probably the next few quarters, maybe more than a year.

So that will probably trickle back in. It's not like that's going to be refunded tomorrow and deliver a huge transfer payment. So still a very fluid, confusing situation, but companies have gotten used to this. And even though this is so noisy, and at times confusing, it hasn't been as disruptive in the last year as maybe a lot of people would have expected.

Phil: That's right. I think it's just another reminder, something we were talking about coming into the year. There's a lot of uncertainty coming into this year. This is another driver of that. I'm not sure it's even a primary driver, but it is just one more thing that investors have to think about as they analyze companies.

Speaking of interesting segments of the economy, let's talk about the housing market for a little bit. So, if you remember, we are coming from a period in which the housing market was really just locked up. Right? Very little supply, affordability very low.

We have seen supply rise a bit, but the truth is, affordability is still a challenge. And this is still a very challenging housing market for those who want to see volume increase and also those who would like to buy a home. So let's dig into that for a moment.

On the left side here, this is home price growth year-on-year. This is using a 20-city index. So this is a broad index looking at year-on-year price growth. And what you could see is we've come down quite a lot and still growing, but very little growth year on year when you look at the largest 20 cities.

Blake: And some markets have negative growth.

Phil: Yeah. I mean, you look at this month-on-month is actually slightly negative for this index. And year-on-year, you are seeing negative in certain markets like Miami, Dallas, Phoenix and others. So depending where you live, you may actually be seeing home price declines. This is good. And from a disinflationary perspective, but also I wouldn't say we have a healthy housing market. We'll talk about affordability in a minute. But first, existing home sales median sale price, Blake, why don't you spend a moment on this?

Blake: Yeah. It's just like at the beginning when we talked about Real versus nominal GDP growth, they're both important things to follow and a lot of times we get caught up thinking about growth, year-on-year changes instead of price levels. And that's what we're showing on the right-hand side is indexed to 2019, what's been the increase in the median selling price?

And an interesting way to think about this is to look at how long did it take for prices to rise by 50%. So going backwards from 2019, you have to go back several years to look at between at what point around 2012 or so prices then rose 50% in 2019.

But since 2019, it only took a couple years for home prices to rise by 50%. So this is a dramatic change. And it is only half of the affordability question, but it is a big part of why we've had a locked-up housing market, why affordability is such a concern. It's frankly just become a bit of a distorted market.

Phil: That's right. And to that affordability point, if you think back to when home prices rose so sharply after the pandemic, mortgage rates were unbelievably low. You had a lot of people moving. Right?

You had a move to sort of the Sunbelt in the United States. There were a lot of drivers distorting the housing market. And by the way, in the context of just not enough supply, which we can look back all the way to The Great Financial Crisis, the reasons that we have a housing shortage just structurally in this country.

So let's talk about affordability. We've shown affordability in a lot of different ways to you all through the years, but here we're showing something that I think it makes a lot of sense. This is just showing median household income relative to the qualifying income that you need to purchase a home. Right? So, in other words, what's your income relative to what it costs to buy a home? Right? Pretty simple.

Looking back, it has kind of been, you know, north of $100,000, let's say, historically. But then we had this period after the financial crisis in which the mean income, this is December 2012, was 201% of the income needed to purchase a home. Why is this? We had the financial crisis. Home values flatlined, fell in many regions. You had lower mortgage rates, but you did have wages finally starting to recover.

By the way, the question in 2012 was, could you get a mortgage? Right? So I think that is a really fair question. But then we've seen affordability just drop precipitously, and really that straight line move lower was right after the pandemic. Why is that? Because mortgage rates have risen, home values have risen sharply as you just covered, and incomes have not kept up. That bottomed, that affordability measure bottomed, in October 2023 at 90% of the income needed to purchase a home.

So you go from 200% of the income needed to purchase a home to 90% in just a decade. It has moved up to 110%, but you're still only at a level we haven't really seen at least consistently since the 1980s. So this is a major challenge, something we hear on the road dramatically. It's a generational challenge, by the way.

Blake: Absolutely.

Phil: And something I think is not going to solve itself quickly.

Blake: Yeah, it's improved on the margin, but in plain English the reality is the typical family can't afford the typical house.

Phil: That's right.

Blake: And that is a structural challenge that's going to either take a long time as incomes grow to get back to where we were from years ago or there's going to be some kind of shock that's going to need to restore balance.

Phil: And by the way, for families that did buy a home before this rise in mortgage rates and prices, they're stuck as well, which has implications for inventory. It's very difficult to sell a home and reset to a higher mortgage at a higher price.

So let's talk about the market for a moment. Something we've been mentioning all year and really is a hot topic is year-to-date we've seen what you hear referred to as broadening. And all that means is we were coming out multiple years where really the largest companies were driving markets, not just in the US, but globally.

US mega-caps were the only game in town. We have seen broadening year-to-date. This is something that we have been waiting for and we welcome. It is healthy to see more than just a few participants in a rally.

So, if you index returns year-to-date and start at the bottom here, Magnificent Seven, those big mega-cap companies, are actually down year-to-date. Interesting. If you look at the S&P 500, depending on the day, it's basically flat. Right? Slightly up, slightly down. That is that dark blue line. So let's look at indices that capture this broadening we're seeing.

First, the dash line, S&P 500 equal-weighted index. Remember, the S&P is weighted by market cap. In other words, the biggest companies have a bigger impact. The equal-weight index, all 500 have the same impact. That is up. In other words, there's broadening out of those top ten companies. Right?

Then let's look at small cap doing even better. Small caps are performing quite well year-to-date. And then looking outside the US, here we're showing ACWI, All Country World Index, excluding the US, that's actually performing the best. So we are seeing broadening. It is not, when you look at the S&P 500, flat on the year. It's a little bit deceptive because the truth is other parts of the market are performing.

This is a real positive if you think about positives and negatives in the market so far year-to-date.

Blake: And another bright spot is earnings. And as we have been hammering for many months and quarters now, including in our annual outlook, earnings are what drive return. That was one of the biggest things I remember Brent wanted to get across in that outlook. That's still a bright spot today.

Looks like last year estimated earnings growth was about 13.3% and it was spread out throughout the year. Year-on-year in Q4 is coming in right at about 13.2% and expectations are for even better growth in 2026 at above 14%. A lot is banking on those solid numbers delivering. So are we going to see that 14.4% revised down? Probably, that happens over the course of most years.

But is it going to still be a big source of optimism throughout the year? We think so. Companies are delivering solid results. The macro backdrop is strong, even accommodative in some ways.

And then look to the right side of this chart as well. It's not only earnings growth, but it's also an acceleration in operating margins. For each dollar that companies are bringing in, they are churning out more of a profit. So these big companies that are delivering an outsized share of returns are doing very well, with very high profit margins.

Phil: Yeah. If one asks why is the market so expensive currently, this is the slide. The answer is we've had great earnings growth, and not just earnings growth, we've had margin expansion. Investors pay for incremental margin. What is your margin on the next dollar of earnings? And that has been quite excellent.

Blake: Alright, Phil. Put me on the clock here. I'm going to try to get through literally one of the biggest trends in investment history that is going on right before our eyes. We are blown away by the numbers that are being thrown out right now of how much big tech companies are spending on AI investment.

Just in the last few years, we've seen Capex for building out AI infrastructure rise from about $250 to $450 billion, and now this year rising by another $200 billion to about $650 billion. It can be hard to make sense of those numbers. $650 billion dollars spent every year is among or literally the largest investment project that we can identify going back in modern history.

So if there was a time where we felt like we could dismiss AI as just some kind of new technology on a whim, some kind of toy, that is not the case. We can all have our opinions on what it's going to do. The reality is, the numbers that are being spent by today's companies are absolutely extraordinary.

This rivals, as I said, the biggest projects in history, building out railroads, the New Deal, the interstate highway system, space travel, 5G. This is a major project and it's being driven by what we call these hyperscalers, the big tech firms that are out there building the internet infrastructure.

We can look at the tenor of big Capex projects over the course of history in an installation phase and a deployment phase. We are solidly in the installation phase. The infrastructure is being built, and no one is exactly quite sure how this will ultimately be used.

Phil: Even those in the industry are very open about the fact that the end game is not known.

Blake: Absolutely, but what you do see in this installation phase is a lot of excitement, even hype, maybe even mania around building out this infrastructure that's expected to deliver outsized returns on investments at some point.

So think all the way back to the 1860s, you built railroads, the installation phase was laying that track thinking "I can move cars across the country." It was not until decades later that we fully knew how to use that. We went from moving livestock and moving train cars across the country to that gave birth to refrigeration. That gave birth literally to the modern economy. That is the case for every major Capex project.

Phil: The internet's another example, right? Early 90s, we were building out the internet, we had no idea what it was going look like even ten years later.

Blake: The internet looked like an easy encyclopedia to users in the 1990s. It gave birth to the iPhone economy, to the gig economy, to TV streaming. So this is a massive deal. And looking at the next slide, we get to the question of is it on track? And right now, yes, we do see demand for what is being built.

In fact, there's major backlogs for what is being built. So yes, the hyperscaler companies are spending $600 billion this year on building out these data centers. Those data centers are oversubscribed. There are people waiting in line to use them, to process their data and to provide services to the economy.

The question though is that high demand does not necessarily translate over time to these investments paying off. And that's not to sound bearish. We're not taking a bullish stance or a bearish stance here. We're just laying out the reality that there is a lot that still needs to happen.

There's a lot that we need to learn to find out if this major investment project is going to pay off. So moving on to think about how is this going to evolve over time. We're going to be monitoring, are we seeing technologies that are just going to be sustaining existing businesses? Is this going to be a cost-cutting measure? Is this going to be driving efficiency gains?

Is this going to replace some roles entirely, just like spreadsheets replace some number crunchers? Or is this going to be a technology that enables an entirely new way of conducting business and living in the economy?

Phil: And the reason we're focused on this and by the way, this is a topic we're going to come back to a lot for many months and I suspect years as well, the reason we're focused on this primary market occupancy or capacity utilization, for example, is if we see this dip, you start to have an issue. Think about for those who remember the telecom boom of the 1990s. We laid all of these fiber optics, but eventually we had what we called a bunch of dark fiber, which was we had laid all this fiber that did not, basically, YouTube was not invented soon enough. It was not being used.

If we start to see these numbers tick down, I think that's a reason for concern. As long as capacity utilization is high, right, and data centers can't be built fast enough, that is certainly a good sign. So we are watching this quite closely. Let's put some scale around this capital spending, which Capex is short for capital spending, as all of you know.

If you look at Capex to sales of the Magnificent Seven, so this is the Magnificent Seven we all know. Looking back in time, of course, this is the highest we've ever seen for Magnificent Seven. A lot of these companies are software companies. They're actually pretty low Capex historically.

And of course, that number is going up in a straight line. You don't spend $650 billion and it doesn't go up. By the way, we are seeing this play out not just in the equity market, but fixed income as well. We are seeing debt issuance from these companies, and some are better positioned than others on that debt issuance side, something that we will be bringing to you and are quite aware of.

So you look at that and you say, okay, well, let's put some historical context around this extremely high Capex relative to your annual sales. So we also had this run for the top 10, and this is going back further. This is going all the way back to the year 2000.

The top 10 changed. Right? Some of the Magnificent Seven were not even public companies in 2000, and certainly the top ten companies looked very different. You would have had energy and others in that top ten.

Even if you look at Capex's sales of the top 10, which changes through time all the way back two and a half decades, this is by far the highest we've seen. So when you hear someone say this is really unprecedented capital spending, it is. That is an accurate statement even scaling by sales, which is a nice way to kind of make it up, an inflation-adjusted number. So something we are watching very closely and will continue to bring to you.

Something else that's really been on the tip of investors' tongues so far this year has been precious metals, particularly gold. We get a lot of questions on this on the road. When we see a price go hyperbolic, as you see here, we tend to get a lot of questions, so that's not surprising. Something we have mentioned before in presentations, I believe I have mentioned in the webinar before, is that yes, gold look, it's an ancient asset class. No one's questioning if it's an asset class.

The real question is the nature of it and how you price it and the volatility, which by the way, we've been reminded so far this year, the volatility of gold. Something I point out in the past is if you bought gold in 1980, in nominal terms, you had this incredibly long bear market. In nominal terms, you did not break even till January 2008. I was thinking in recent weeks about this and saying, well, but if gold is truly an inflation hedge, which is one of the primary reasons people buy gold, we really should be looking at its price inflation-adjusted, which is what this chart is.

If you bought gold inflation-adjusted in 1980, it was 45 years, September 2025 when you broke even. Does not mean gold's not a real asset class. But when we say be careful with commodities and their volatility, this is what we're pointing to. Basically, any other investment in 1980 would have performed better. A money market, fixed income, certainly equities.

This has been a tough road. Now gold is going up. We understand why, but that does not necessarily mean it continues to go up in a straight line as we've been reminded in recent weeks.

So let's talk about our S&P 500 price target. As a reminder, our price target is a forward 12-month price target. It's not the end of the year. We roll it forward. We tend to update this relatively often, roughly quarterly. So this is our quarterly update to the price target. Our base case prior to this was 7,200.

Based on the recent earnings season and running our numbers, which there are numbers behind this, our price target goes up very modestly to 7,300. So when we say we're cautiously constructive, I would argue that we're pretty consistent there. We had a good earnings season. That comes into our numbers.

So in this base case, that's up nearly 7% from the close on February 23rd. In that base case, we are looking at basically next 12-month earnings coming in as consensus hopes, and then a little bit of a shift down in earnings growth to high single digits compared to what we've seen in recent years with a little bit of multiple or price-to-earnings ratio contraction.

So, again, a fairly cautious base case, still indicates up, but not anywhere close to the returns we've seen in recent years of, you know, very high, well into double-digit returns, but still positive.

Our bear and bull case, also adjusted those up modestly about a 100 points to 5,300 and 7,900. Something that persists though is if you look, there's more downside to our bear case than upside to our bull case. That asymmetry plays out in our data, and it just shows that when you've run this far and this hard, there is more downside than upside in the bear and bull.

Of course, you can have all sorts of exogenous factors where we can move even outside of these bear and bull cases, but that's our framework, and really no one picks where the market's going to be exactly in twelve months. That would be incredible if someone could do that.

But this is our framework, and this is a way for us to show you how we are thinking about the market. Up, but not up in a straight line, and we do think the volatility we've seen this year, some moving around, some broadening could be the theme of the year in full.

Blake: Phil, I like how you left on that slide cautiously constructive, the title of our 2026 outlook really sums up our views on equities. Fixed income is delivering solid returns. And that's why we keep putting this slide in these presentations is to continue to remind clients that unlike the previous decade, fixed income is a real return-generating asset class.

Yields are a little changed this year compared to the end of 2025. We've seen a tick down in yields, particularly in Munis, which is reflecting really strong demand in that class this year. But across the board mostly very little change so far this year. Aggregate fixed income still delivering in the low 4%. What about credit spreads? Credit spreads are still priced extremely tight reflecting optimism and a relatively low perception of risk to credit markets.

Phil: And we should say, what is a credit spread? It is simply the spread that a credit's investment grade or high yield that you see here. You have to pay you to own them above treasuries. In other words, if this number's high, that means there's a lot of credit risk in the market and investors are saying, no, no, no. You need to pay us more to lend you money relative to treasuries. When this is tight, it's saying that there's not nearly as much risk in the marketplace.

Blake: Investors aren't demanding as much compensation for that risk. And given some of the things that we've talked about, being cautiously constructive on the outlook, this feels like a little bit of a risk to one side, but it is the market telling us that the outlook for this year is fairly strong.

Phil: And something, especially with debt issuance of hyperscalers, which we are watching very closely.

Blake: Absolutely. Lastly, just a reminder that there's a big difference in the way that interest rates further out on the curve, think 10-year Treasury, 30-year mortgage behave, compared to at the short end, which is where the Fed is operating.

So in the last couple of years, we've seen two rounds of the Fed cutting interest rates. One starting in September of 2024 and second starting in September of 2025 for a total of 1.75% in cuts. Look at how, so look at that dash blue line. See that's down 1.75% from when the Fed started.

Phil: The Fed cutting, right?

Blake: However, the longer-term interest rates have not moved nearly as much and in fact at times throughout the last couple of years where we're showing this chart, longer-term yields actually moved up.

The point of this chart is just to be reminded that there's a lot more going on further out the curve. And if that's where a lot of investments are being considered, then we have to think separately just from how the Fed is going to be operating.

Phil: Look, this is something that we encounter a lot on the road, which is the concept of "I want the Fed to cut so that my mortgage rate will go down." That's not necessarily the case. Look at 2024. The Fed was cutting, mortgage rates rose. Right?

Why is that? Mortgages are more correlated with things like the 10-year and 30-year Treasury than they are with the fed funds rate. Alan Greenspan called this the Great Conundrum.

It's just unfortunately not as simple as "the Fed cutting and all rates fall." It is good to see the recent moderation in mortgage rates in the 10-year Treasury, but nowhere near keeping track with the fed funds rate. That's why we have seen a steepening. Well, Blake, thank you so much today, and thank you everyone for joining. Amy, why don't we jump right into Q&A?

Amy: Hey, before we jump into questions, just a quick reminder that we have several publications available throughout the month. If you'd like to get those publications sent directly to your inbox, be sure to use the QR code on the screen to get signed up or visit FirstCitizens.com/Market-Outlook to get signed up. You can also search for us on Spotify, Apple Podcasts and YouTube Music.

Well, guys, thank you so much for answering questions. And Blake, thank you so much for being with us. I really enjoyed your section on AI and where that's going. Can you talk a little bit about, I know a big question for people is, are these bets going to pay off in the future and what the future might look like?

Phil: Yeah, I think that that's the big question. Unfortunately, it's unknown. If it was known, the market would be perfectly priced at all times. What we do know is that, as Blake outlined, the capital spending, the capital expenditures are record-level and only increasing. It feels like every earnings season companies up their numbers. Right? We're watching for that earnings season which maybe they don't.

But this is a story that feels like we're still in the early chapters of this. My mind—you mentioned rail, I mentioned Internet—my mind often goes to the 1990s which was, look, in 1994 we didn't know what this personal computer and internet how it was all going to turn out. We had some pretty high confidence it was going to change the world, and it did. But also, a lot of those companies weren't priced properly. Right?

And we still had a tech bubble. But that tech bubble wasn't till the year 2000. So it's very hard to know, but that is why people like us are watching capacity utilization so carefully and are really focused on it. We are aware and I think the consensus is aware that these bets have to pay off.

By the way, Magnificent Seven is down year-to-date, Blake. I don't think that's a coincidence. People are trying to sort this out. But saying that there's certainty, if one says that, I look at them skeptically. I just don't think we have much certainty yet on how this turns out.

Blake: It sounds like an obvious point, but it's worth repeating. You said they have to pay off. A lot of the major capital expenditure investment projects of the last 150 years didn't have to pay off. The interstate highway system didn't have to pay off. It was a public project designed to move military troops across the continental United States. It's now used to connect East Coast to West Coast and national commerce.

Phil: It ended up being huge for us, yes.

Blake: This one does have to pay off. These are private companies investing the equivalent of 2% of GDP every single year into a project that is expected to deliver investment returns. There's a couple helpful ways to think about massive projects that historians and technologists have put together. The first, as I mentioned, is this installation versus deployment phase.

And we're in this installation phase. We're building the infrastructure and there will be winners and losers. You don't get a participation trophy for participating in the infrastructure build out. You have to be able to profit from it.

And that's where you get to the deployment phase and that is always going to be unknown as you are getting into a massive technological infrastructure build-out. So it is just it's highly unknown. There are ways to keep track of it. We are keeping an eye on "Are these projects that are being used in the data centers, is there an outlook for them to deliver profits?"

Are we going to get beyond just cost cutting and summarizing documents and writing code for developers? Are we going to get to more transformative technological developments? I mean, some of the people really driving this issue foresee a future where you have AI that is doing a lot of work on its own. They see a future that's filled with humanoid robots. I mean, the future is that it's a blank canvas out there. No one really knows how it's going to go. What we do know is that this is a massive investment and it has to pay off.

Phil: And what we are seeing this year for those who watch markets day-to-day, one thing we are seeing is a large language model company has a new solution, right, and that solution might affect existing software companies. Those software companies sell off, right? So there are early indications of some of these efficiency gains.

To your point, it's very efficiency-gain, cost-savings type things. Is it changing how business is done? No. It's really making it more efficient. But you know what? The personal computer did that and it was still a very big deal. So the unknown is this is why it's called the unknown.

We are seeing early indications, but for all the experts we talk to and we're lucky enough to get to speak to a lot of people in AI, I mean, maybe we're in the second inning of this. Maybe. This is still very early days in terms of impact. But impact and what a company is priced, what's in the price of, say, a hyperscaler are two very different things. And we have to remember that as investors.

Amy: And Phil, how many participation trophies would you say are on your shelf at home?

Phil: Zero. Zero. I'm a little bit older than you guys

Amy: So we've talked about market valuations and the market being expensive. Phil, what are you saying to people on the road when they ask you about entry points and whether there's still opportunity out there?

Phil: Yeah. Look, we get this question a lot. We've gotten it a lot honestly for a couple of years now because we've had a pretty expensive market. What we always remind clients is there's not one answer for everyone. Right? For a young person early in their career, maybe don't worry about entry points at all.

Late in the career, depending on the circumstance, closer to retirement, it may really matter. But in the end, and recent years have proven this and reminded us that really it is time in the market that that pays off over the long run. All of this sounds quaint, but you just don't have to look very far back. The market was just as expensive a year ago as it is today, and you had a great 12-month performance in the stock market.

So, by the way, when we talk about earnings growth, if earnings continue to grow the way they're expected to this year and we have more modest returns than the stock market, which is our base case, you may actually see the market become cheaper. Right? Think about price-to-earnings. Right?

Price goes up less than earnings go up, the market becomes cheaper. We have actually seen that so far this year. Why is that? Stock market's flat, earnings have continued to grow. So don't worry as much about entry point. Worry more about having a financial plan and thinking about your needs and wants relative to your endpoint, your end goals, rather than where the market is on a given day.

Amy: Great. Yeah, makes sense. Thank you both for answering questions as always and taking a deep dive into markets and the economy. And to all of our listeners, we want to thank you, as always, for trusting us to bring you this information, and we look forward to seeing you next month.

Authors

Brent Ciliano CFA | SVP, Chief Investment Officer

Capital Management Group | First Citizens Bank

8540 Colonnade Center Drive | Raleigh, NC 27615

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

Phillip Neuhart | SVP, Director of Market & Economic Research

Capital Management Group | First Citizens Bank

8540 Colonnade Center Drive | Raleigh, NC 27615

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

Blake Taylor | VP, Market & Economic Research Analyst

Capital Management Group | First Citizens Bank

8540 Colonnade Center Drive | Raleigh, NC 27615

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

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