Market Outlook

Making Sense

Q3 Portfolio Positioning

Recorded: June 24, 2025

Amy: On Tuesday, June 24th 2025, Thomas O'Keefe sat down with Phil Neuhart to talk about the underlying factors driving the portfolio decisions for Q3. 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.

Phillip: Thomas, thank you so much for joining us, really happy to have you here. This is the first time we're going to do our allocation discussion, and it's going to be in podcast form in addition to video—so very excited for that.

Thank you also for flying out here. You're in Raleigh, North Carolina, joining me here. You're normally based on the West Coast. I hope you're enjoying this incredibly hot, humid weather.

Thomas: It's great. Got in last night, had a run this morning, and didn't get heatstroke. So I'm glad to be here with you guys.

Phillip: Yeah, happy you made it. Look, there's a lot going on in the world. We, of course, have the Israel-Iran conflict, US participation there. Trade remains on everyone's minds. We have trade delays, 90-day delays that are rolling off in coming months. How do we think about our allocation process in times of so much geopolitical activity?

Thomas: Macroeconomic events are very hard to predict. So within our process for allocating capital, we have a very difficult time actually thinking about those in our underlying allocations.

We are bottom up, not top down, in nature. So we don't look—what that means is we don't look at an event, say, the conflict that's going on in Iran right now, and we don't say, "What is the trade that we can make based off of that event?"

Phillip: In reaction to it.

Thomas: That's exactly right. So what we do instead is we look at the data. So sometimes the data that we look at is going to actually show some of those events—or the impacts of those events—within that data, and sometimes it won't. But we're studying those on a regular basis—on a daily basis, really, the whole team is—to make sure that we're seeing where that impact is being made.

Great example of this is actually the trade policy and the tariffs that are going on. Inflation, right? You would think, you would assume if you were looking at it top down, that inflation would have jumped up very quickly after the announcement of the tariffs. But in reality, we haven't actually seen that.

Phillip: Right.

Thomas: So this goes to show you that macroeconomic events, even though we are concerned about them from a headline perspective—we see it, right? We're watching the news, we're seeing it. Everyone's seeing it. Top of mind for us. We're worried about the impacts of all of these things. But in reality, the markets react in very different ways.

So it's hard to predict, and even more importantly, it's hard to time. We don't know when the right trade should be made. Is it today? Is it tomorrow? Is it the next day? So we want to be very true to our process, very true to our bottom-up, data-focused process, that makes sure that we're not overreacting to an event just because it's in the headlines.

Phillip: Right, and sometimes I think about a quantitative approach to investing is you have all of these variables, sector-based, you know, dozens and dozens of variables. Events do get captured in data, whether that be movement in rates or movement in spreads or even economic data if it feeds through to economic data.

But you don't react based on a headline, but the headline might find its way into the data and could certainly impact portfolios at least on a margin. Is that a way to think about it?

Thomas: Yeah, it's absolutely right. So let's say, for example, tariffs again. If we see companies insecure about what the future holds for them, maybe they're not spending as much on new projects, right? So maybe we're seeing that in the CapEx expenditure. Maybe we're also seeing it come through in revenues. What if they're eating some of the cost of those tariffs, right? So then the actual data that we're seeing pop through for those companies is actually declining.

So sometimes there's a lag to these things. But really, we want the data to inform the decisions we're making so we don't get caught in a situation where we're allocating at either the wrong time or to the wrong factor.

Phillip: Right. So speaking of allocation, what are some of the themes in this quarterly allocation process that we're going through?

Thomas: Yeah, I would say, we've found really two themes. These are consistent with the themes that we've seen over prior quarters. But I would say, the first theme that we're seeing is really, valuations continue to be high. And they continue to be high everywhere. Some asset classes we see more sensitivity to valuations than we do others. And some places we actually see, compared to their historical valuations, are actually trading quite attractively.

Some examples of this, growth US—large-cap, specifically large-cap growth US—is not as sensitive we have found to valuation as, say, large-cap value. So it's easy for us to feel confident investing in large-cap growth even with high valuations.

Phillip: Right.

Thomas: Whereas you could see large-cap value, certainly higher valuations in that space, presents a problem for us in terms of entry point for a particular investment.

The other theme we're seeing really strongly across the board is a slight deterioration in economic data has actually produced stronger, future-return forecasts. So that might sound counterintuitive.

Phillip: So yeah, let's dig into that. You buy the weakness is basically the idea?

Thomas: That's right. So if we're looking at this, again, time periods really matter here, right?

Phillip: Right.

Thomas: Because we might see, for example, employment data go down a little bit. Or we might see PMI is not as strong as they were in prior quarters. And you might think, "Well, the economy is weakening. We should be selling out of our risky assets, selling out of equities." But in reality, when we're looking at forecasting for future returns, a lower economic, sort of lower economic data or poor economic data, actually presents a contrarian view that we should be buying into that.

Phillip: Which makes some sense when you think about it, right? The herd mentality usually does not work. And economic data, while softened, it's not weak, right? We've just seen a little bit of softening in data and something we're certainly talking about.

Thomas: Sure, and you could extrapolate this a little bit, right? And you could say to your point, well, if the economic data became very bad, then you might have a situation where we're in a recessionary environment, valuations are going down significantly, maybe that's not as big a buying opportunity as we might want.

But with a slight deterioration, actually, those future forecasts actually look quite strong for certain asset classes. US large-cap growth is a perfect example of that. We see lots of quality companies within that asset class. And so even with a small deterioration, we are seeing increased future expected returns.

Phillip: Let's talk about diversification in portfolios. You mentioned growth value, but obviously, we own across the cap spectrum we own international. We really are a diversified approach to investing, or we utilize a diversified approach to investing. Talk a little bit of that and just remind our clients our approach there.

Thomas: Yeah, well, diversification is huge, and it really is just one component of our overall risk management process. Risk is really important to us, right? Returns are great. We love returns. But we want to make sure that we're doing it in a risk-prudent way.

So we have many levers, many ways that we can within our process manage for that risk. One is through diversification, right? And that diversification is really through making sure that we are tracking to the stated benchmark that we're looking to track.

We get too far away from that—basically, tracking error—if we have too much tracking error, then what we're doing is we're saying that we're taking a bet on a particular place. That's adding risk, it's adding volatility and it's getting away from the core of what we're doing. So we have lots of different metrics, lots of different guardrails. We even have position guardrails, making sure that we can't go too extreme in one place or another because then what ends up happening—back to our macro event—if we did end up doing something or making a trade that says, let's say, for example, we should be overweight emerging markets in this particular place. Well, what happens if we end up being too extreme in that viewpoint? Well, maybe our timing is off, right? And so all of a sudden, our prudence and our risk management has been lost.

And we want to make sure that we're constantly being prudent in diversifying, making sure our portfolios are going through every single detailed process that they need to go to in order to make sure that we are not overexposing our clients to a factor that they didn't want to be exposed to at the end of the day.

Phillip: Yeah, those guardrails are really important. As you think about risk and times of elevated headline risk—obviously, right now is one of those times—do we approach risk differently at times like this, or do we take a more consistent approach?

Thomas: We try to be consistent in every time period, whether it's good or bad. You don't know what the future holds, right? And so the last thing you want to do is sacrifice the discipline that you have within your process just to take advantage of what you think is an opportunity. That's where you always fall flat.

Phillip: Right.

Thomas: And so as a professional investment adviser and allocator for our clients, we want to make sure that we're doing that work for them and not being overly reactionary to these sorts of things.

Phillip: Right. What other allocation shifts are we making this quarter that you might want to highlight?

Thomas: Yeah, I think from a high level we already touched on a few of them, but I would say we continue to be slightly overweight growth versus value. And this is back to what I said earlier, where we find growth is not as sensitive to high valuations as value is—and also has a better opportunity of taking advantage of the slight deterioration in economic data. So still a very slight overweight to growth versus value.

We still continue to have an overweight in small cap. A lot of this is based off of, we just find comparatively the valuations in small cap are more attractive than they are in large cap. So you see us shifting a little bit of capital over to small cap. This is an overweight we've had for quarters and we continue to have.

Phillip: Right.

Thomas: I'd say international versus US is an interesting one. You might think from a high-level, macroeconomic headline perspective that international is a challenging place to be in right now. We are slightly overweight international.

Now this is not me saying we like international more than US. What it's saying is we actually really like international small cap right now. Now this is a satellite holding within our portfolio. Let me just explain what satellite is. So satellite is basically any position that doesn't fall within the benchmark. So there's a pretty high bar for us to add anything that doesn't fit in that benchmark.

So that international small cap, we really like the relative strength of its valuation. So similar to US small cap, international small cap also has strong valuation compared to its peers—basically, all the other asset classes. It also, similar to large-cap growth, has a better profile when the economic data deteriorates. So we find that international small cap is a great place to be right now. We had an overweight to it, and we're increasing that overweight slightly.

On the flip side, emerging markets, we are decreasing our allocation, or I would say we are increasing our underweight to emerging markets. This is a challenging place to be right now. I would say, mostly when we look at the data and we look at our models, emerging markets has historically higher volatility than all the other asset classes. So when we compare it to something like international small cap, which is in developed markets, we see more volatility in emerging markets. And therefore, the models don't like it. And we tend to underweight emerging markets in these periods where volatility can put us in a poor position from our risk management process.

Phillip: Right, so still invested in US, maybe a little bit down the market-cap spectrum into mid and small, overweight international developed, but that's really a small cap—international developed small cap—but underweight emerging markets would kind of be the holistic view. Is that pretty fair?

Thomas: It's exactly right. And I'd say if we make one more point on emerging markets, it's easy to look at the headline risk and say, "Well, of course, you're underweight emerging markets. Look at what's going on in emerging markets."

There's also, you know, a very large allocation—the highest allocation in emerging markets—to China. So you can see that there's high-level macro themes that look like they're headwinds for emerging markets. I'd say, yes, we believe in that. But also, it's coming out in the data in terms of the volatility, in terms of the risk that we want to manage through. So it's not—I say we don't manage to the headline and to the macro, but that story is consistent.

Phillip: Yeah, as we said earlier, it finds its way into the data.

Thomas: That's right.

Phillip: And that's why we'd rather have a systematic approach to investing. Well, as always, thank you so much for joining us today, really a pleasure. Look forward to next time.

Thomas: Thanks for having me.

Making Sense

In Brief | A look at the week ahead in under two minutes every Monday morning

Q&A Videos | Monthly conversations covering 2 to 3 of the top questions we're hearing from clients

Market updates | Monthly interactive discussions with in-depth analysis of markets and the economy

Written Commentary | Often coinciding with market or economic events

Brent Ciliano, SVP

Chief Investment Officer

Phillip Neuhart, SVP

Director of Market and Economic Research

Blake Taylor

Market and Economic Research Analyst

Sign up using the QR code to have these updates emailed straight to your inbox. Or visit FirstCitizens.com/Wealth to subscribe.

Authors

Phillip Neuhart | SVP, Director of Market & Economic Research

Capital Management Group | First Citizens Bank

8510 Colonnade Center Drive | Raleigh, NC 27615

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

Thomas O'Keefe, CFA, CAIA | Managing Director

Capital Management Group | First Citizens Bank

222 Second Street | San Francisco, CA 94105

TO'Keefe@SVB.com | 408-761-6592

Important Disclosures

The views expressed are solely those of the authors and do not necessarily reflect the views of First Citizens Bank & Trust Company or any of its affiliates. This material is for informational purposes only and is not intended to be an offer, recommendation or solicitation to purchase or sell a specific investment strategy, any security or insurance product and should not be construed as legal, tax or accounting advice. Please consult with your legal or tax advisor regarding the particular facts and circumstances of your situation prior to making any financial decision. While we believe that the information presented is from reliable sources, we do not represent, warrant or guarantee that it is accurate or complete.

Many companies referenced in this content are independent third parties and are not affiliated with First Citizens Bank & Trust Company. All third-party trademarks, including logos, trade names, service marks and icons referenced remain the property of their respective owners.

Your investments in securities and insurance products and services are not insured by the FDIC or any other federal government agency and may lose value.  They are not deposits or other obligations of, or guaranteed by any bank or bank affiliate and are subject to investment risks, including possible loss of the principal amounts invested. Past performance is no guarantee of future results. Estimates of future performance are based on assumptions that may not be realized. This material is not a solicitation of any offer to buy or sell any security or other financial instrument or to participate in any trading strategy. Diversification does not guarantee a profit or protect against loss in a declining financial market.

First Citizens Wealth™ (FCW) is a marketing brand of First Citizens BancShares, Inc., a bank holding company. The following affiliates of First Citizens BancShares are the entities through which FCW products are offered. Brokerage products and services are offered through First Citizens Investor Services, Inc. ("FCIS"), a registered broker-dealer, Member FINRA and SIPC. Advisory services are offered through FCIS, First Citizens Asset Management, Inc. and SVB Wealth LLC, all SEC-registered investment advisors. Certain brokerage and advisory products and services may not be available from all investment professionals, in all jurisdictions or to all investors. Insurance products and insurance are offered through FCIS, a licensed insurance agency. Banking, lending, trust products and services, and certain insurance products and services are offered by First-Citizens Bank & Trust Company, Member FDIC, and an Equal Housing Lender, and SVB, a division of First-Citizens Bank & Trust Company. icon: sys-ehl

For more information about FCIS, FCAM, or SVBW and its investment professionals, visit www.FirstCitizens.com/Wealth/Disclosures.