Making Sense: Market Outlook
CFA | SVP, Chief Investment Officer
SVP, Manager of Institutional Portfolio Strategy
Each month, Brent Ciliano, CIO, and Phillip Neuhart, Manager of Institutional Portfolio Strategy, help you make sense of the markets and the economy. This Market Outlook covers a summary of the August 25 Making Sense webinar.
GDP is back to pre-pandemic levels, but US Consumer confidence wanes with COVID-19 delta variant uncertainty
The sharp recovery in US economic growth continues, though analysts have begun lowering growth estimates for the remainder of 2021. Much of the downward revisions reflect uncertainty with the delta variant. Despite the strong economic recovery, expectations for 2023 and beyond reflect a return to the below trend growth environment, not unlike what followed the Great Financial Crisis.
Where do markets go from here?
Wall Street consensus 12-month forward price target for the S&P 500 is 4,921.25 as of August 23, or an approximate 10.8% return from August 20, 2021's market close.
We believe markets will continue to make higher highs through year-end 2021, with volatility and potential seasonal pullback during late summer and early fall (-5% to -7%), followed by higher highs into the end of 2021. We estimate the S&P 500 may see 4,700 (or higher) by year end, a 5.8% increase from August 20, 2021 market close.
What does lower consumer confidence mean for the economy?
The US Consumer explains more than 73% of US real GDP 69% from consumption and another 4.7% from US housing. Thus, as goes the consumer, as goes our economy.
With resurgence of COVID-19 cases, higher consumer prices and goods scarcity (think new and used autos, housing and rental inventory), consumer confidence has fallen to the lowest level since 2011.
Corporate earnings continue to soar, but let's look to the horizon
Second quarter's estimated earnings growth rate for the S&P 500 is 89.3%! That puts us on track for the highest year-over-year earnings growth rate since 2009. But how long will it continue? We believe there are three key headwinds:
- Likelihood of corporate tax increases in 2022
- Continuing supply chain issues may lead to lower revenues
- Skilled labor shortages may lead to higher wages
Inflation remains high, even as transitory components ease
We continue to expect the Fed will begin tapering bond purchases in December of 2021 and concluding by the end of 2022. We see declining issuance from the Fed as the prevailing factor impacting the US Treasury market going forward. The delta variant and continued growth concerns will likely keep rates range bound for the rest of this year and potentially into the first half of 2022.
As for rate hikes, market-implied pricing shows the first hike has pushed out from October 2022 to December 2022, followed by two hikes in 2023.
Making Sense: A Market Update
Watch the replay of the August 25 webinar, where Brent Ciliano and Phillip Neuhart discuss what's going on in the markets and economy.
Amy: Hello and welcome to the First Citizens Wealth Management webinar series Making Sense, where Chief Investment Officer Brent Ciliano, and manager of Institutional Portfolio Strategy Phil Neuhart, help you make sense of what's going on in the markets in the economy. I'm Amy Thomas, a Delivery Specialist with First Citizens Bank, and I want to thank you for being with us today. While everyone's logging in, I want to walk through a couple of housekeeping items with you.
First, this webinar is being recorded, and a replay will automatically be sent to you after the conference. Secondly, this webinar is an interactive. You'll have the opportunity to ask questions. If you submitted a question during the registration process, thank you, we have your question. Should you have a question during the call, please use the Q&A or chat feature to submit your question on the right-hand side of your screen. All questions are confidential and only visible to myself and the panelists.
I do want to remind you that we try to keep the discussion broad. If you have a specific question about your financial plan, or we're not able to answer your question during the webinar, please reach out to your First Citizens partner. As a reminder, the information you're about to hear are the opinions of First Citizens Bank and are for educational purposes only. If you have any concerns regarding this information, please reach out to your First Citizens Relationship Manager. We hope you find this information helpful. Thank you again for being with us. And with that, I'll kick it over to Brent to get us started.
Brent: Great, well thank you Amy, and good afternoon, everyone. I hope all of you are well. It's so hard to believe that we are only a week away from the end of summer. Where did it all go. so fast? So for today's call, Phil and I are going to discuss, are we past peak economic growth in the US? Where to now? What about Delta? Will it extend the peak a little bit longer? We're going to break the US consumer discussion down into two parts.
First, the US labor market, it's picking back up. Will the pace continue to accelerate or slow back down? What will be the key fundamental drivers to that? Then we're going to talk about the consumer. Confidence and spending are falling. What might that mean for growth? We're then also going to talk about US corporate earnings. They continue to soar. How long will this last and what could potentially get in the way of this juggernaut? Then Phil's going to talk a little bit about yields. Yields continue to be volatile. Where do they go to from here and when? Inflation, it's certainly still high, but transitory components are starting to ease a little bit, but not durable inflation.
Lastly, I want to get pretty specific on where we think the market goes from here through both the end of the year, but I also want to discuss how long the equity market cycle could last and how high the market may go by showing you a little bit of market math. You didn't think you're going to be doing math in the middle of the summer on a Wednesday, did you? But we're going to do a little bit. So without further ado, Phil, why don't you kick us off?
Phil: Great thank you, Brent. Let's jump right into US economic growth and slide four. So as you can see here, the COVID-19 pandemic gave rise to the sharpest economic contraction in more than 70 years, that falling 10.1% and shaving an incredible $2 trillion in economic output from the peak. This was the third largest contraction in US history behind the Great Depression and the post-World War II demobilization period. But the recession was short lived. It only lasted two months with a full recovery in a little over eight months. While the recession itself was one of the shortest of all time, the recovery time was right in line with historical averages post-World War II.
The sharp recovery in US economic growth continues, though analysts have begun to revise down growth estimates for third quarter of this year. Much of the downward revisions are more of a deferral to the fourth quarter of this year, and first two quarters of next year, rather than an outright reduction in the broader US growth outlook. Much of the downward revisions reflect Delta variant concerns, as you might expect. Despite this strong economic recovery expectations for 2023 and beyond reflect a return to below trend growth environment we witnessed following the Great Financial Crisis.
While leading economic indicators which you see here turn back up in July and sit at multi-decade highs, we turn to the next slide, we are likely to see a Delta variant driven slowdown reflected in data, at least for August, but potentially longer until both newly reported cases and hospitalizations subside. The effects of a COVID boost are unlikely to be felt until late 2021 and into early 2022 as a vast majority of Americans who have been vaccinated were vaccinated in the March, May 2021 time frame. So we're reflecting that eight month post last shot recommendation.
However, we have seen the pace of first-time vaccinations increase in recent weeks as the Delta variant has spread. Additionally, the Pfizer vaccine received full FDA approval this week for those aged 16 and older, which could further increase vaccine rates as more entities require vaccinations. More headlines said on that each and every day. Now we'll pass it to Brent to cover the all-important US consumer.
Brent: Great, well thank you, Phil. We've covered in detail on each and every monthly call this strong recovery in the US labor market after COVID-19 gave rise to the largest labor force contraction in the history of our country. In two months, we lost 22.4 million jobs. The unemployment rate skyrocketed from 3.5%, all the way up to 14.8%. But from May of 2020 all the way through July of 2021, the US has added back nearly 16.7 million jobs, which represents about 75% of what was lost. And the unemployment rate, thankfully, has fallen back down from 14.8%, down to about 5.4%.
But folks, the big question the Fed and markets desperately want answered is how fast and when will the labor market be on strong enough footing to let up on the monetary gas pedal to start tapering their bond purchases? Well, if the current run rate of about 800,000 plus jobs a month continues, we could see a full recovery to the pre pandemic levels somewhere around the October of 2022 timeframe, which is a move up from the first quarter of 2023. So let's transition and talk a little bit about what might speed up this recovery, but what also could potentially get in the way.
We believe the biggest catalyst for further employment gains will be that on September 3rd, 9.4 million people currently collecting federal unemployment insurance benefits will lose all income support. And then, interestingly enough, last week or actually on Thursday of last week, the Biden administration set an a letter to congressional leaders that it is appropriate for expanded unemployment benefits to expire as scheduled, but states and local governments can use pandemic relief funds for added health beyond the deadline if they deem necessary.
On the bottom right to kind of give a lens into where we might be going from a labor market recovery perspective, 26 states ended federal UI benefits early. 22 in June and another four in July. That's that red line on the bottom right. The states that ended those benefits early saw a commensurate 20% decrease in unemployment insurance claims versus states that did not. So we believe that the confluence of eliminated federal benefits plus the return to school return to work will likely put the US labor market back on a solid pace to recover to its pre pandemic trend. Now certainly, Phil and I will be watching the rate of COVID cases and hospitalizations, as that could certainly throw a monkey wrench into this recovery if, God forbid, schools were to have to shut down or our broader economy would have to be shut down again, which we do not believe is the case.
When it comes to US growth, it is, and it's pretty much always been about the consumer. The US consumer explains more than 73% of US real GDP. 69% comes from spending. Another 4.7% comes from housing. So as goes the US consumer, as goes our economy. And while the consumer has been spending and continues to spend today, consumer confidence has fallen back down to the lowest level that we've seen since 2011, much of which is being driven by the resurgence and Delta variant Covid cases, higher consumer prices and goods scarcity. Think about new and used cars and trucks are harder to come by. If you aren't driven by a dealership, what's on the lot is scarce. Housing and rental inventories that are virtually nonexistent and expensive today.
This is feeding back into consumer's views on big ticket spending items, specifically consumers talking about whether or not it's a good time to be buying a home or a car. That metric has fallen back to its lowest levels since the early 1980s. These big-ticket items are a very large component of consumer spending folks, and if spending does fall in these key areas, it's likely to have a significant effect on the overall magnitude of consumer spending and potentially lead to lower real GDP in the future. We don't think that's the case now, but it's certainly something that Phil and I will be watching.
And as you can see here, top left is housing, bottom right is motor vehicle sales and parts. And unfortunately, consumer actions have now started following those confidence readings with spending on housing and autos having rolled over a little bit. And again, Phil and I will be watching this pretty significantly as things go forward.
So let's transition and let's talk about corporate earnings with almost all of the S&P 500 companies having reported for the second quarter, corporate earnings continue to soar. Right so we're looking at 89.3% growth year over year for the second quarter. If that sticks, it'll be the highest year over year earnings growth rate reporting by the S&P 500 since the fourth quarter of 2009, right after the Great Financial Crisis. For the full year, earnings are expected to grow at an incredible 42%. Again, let me put this into perspective. The 50-year long term earnings growth rate for the S&P 500 is a Meager 6.5%. This year, we're going to grow 6.4 times the long-term average. To make matters even better, for 2022 we're expected to grow another 9.4% on top of that, which is about one and a half times the long-term average of 6.5%. So just incredible growth and amazing results like S&P 500 companies have been putting up.
And these if we transition to the next slide, Amy, and these incredible numbers are not just base effects off of pandemic lows, these staggering growth numbers are over and above the high watermark that we set back in 2019. And if you look at this chart that I'm showing you, sales are up over the high watermark 15%, gross income up 21%, so I think sales or revenues minus cost of goods sold. Earnings before interest and taxes, right, operating earnings up an incredible 33% and net earnings are up 34% over the highest level that we've seen in history. Additionally, S&P 500 gross profit margins at 36% are at 40 plus year highs. So just incredible, incredible growth for S&P 500 companies.
So let's talk about what's going on beyond some of these record-breaking results that we're seeing with companies, there's three potential headwinds to this story. The first headwind is the very high likelihood of higher corporate taxes in 2022. We believe that Congress will put something through in the October time frame for both corporate and personal taxation. The consensus-based case right now on corporate taxation right now is our corporate tax rate to move up from 21% to 25% and a 15% to 18% rate on global intangible low tax income rate or the guilty rate for overseas derived income. The bottom line is that the effects of higher taxes on corporate earnings are expected to reduce 2022 corporate EPS by only about 3% to 5%.
Not insignificant, but certainly will be a drag on corporate earnings. The second headwind, which has been coming up on a lot of analysts calls with companies is continued supply chain shortages, production bottlenecks that potentially feed back into higher input costs, input scarcity and ultimately lower revenues as fewer goods are produced from set for sale. The third headwind is the continued skilled labor shortage, which is leading to higher wages, think hire business costs. All right.
The number one cost on most companies balance sheets is human labor and capital, as well as output and service disruptions. And if you look at the top left, the NFIB survey for small and medium sized businesses is still reporting that the single most important problem for small and medium sized businesses is quality of labor. And on the bottom right, small businesses are reporting few or no qualified applicants. That level is sitting at the highest level in more than 20 years. So that certainly could feed back into higher wages and also inability to really drive production and output and might lead to further service disruptions. So with that, I'm going to turn you over to Phil to talk about interest rates and inflation.
Phil: Sure thank you, Brent. Let's jump right into rates and Fed policy. So we continue to expect Fed tapering of their balance sheet to start in the late fourth quarter of this year. Final decisions by the Fed on this start of tapering are unlikely to be finalized until at or after the September FOMC meeting, given the need to solidify the direction of the labor market, where there's still a lot of uncertainty. Market consensus is pricing a probability of about 50% that tapering concludes by the end or begins by or rather concludes by the end of 2022 beginning late this year.
Of the technical factors that will likely impact US treasury markets going forward, tapering and declining issuance, we see the latter as the prevailing factor. Consensus expectations for reduction in treasury issuance range from a decline of 15% to 30% in issuance during 2022. That significant reduction in supply of treasuries will likely support prices while the Fed is stepping out of the market. We believe the Delta variant and continued growth concerns keep rates range bound the rest of the year and potentially into the first half of 2022. Market implied pricing shows the first hike has pushed out from October of 2022 to December of next year, so it's been pushed out a few months, then two hikes in 2023.
We turn to the next slide. Despite peak economic data, investors, as you can see here, continue to worry about the growth outlook keeping rates low. More broadly, the movement in rates seems incongruent to both the broader economic picture as well as the statements and minutes released by the Fed. So is the bond market telling us something that we don't know? We believe the economic recovery remains solidly in place, but is worth watching movements in the yield curve, speaking of which, the yield curve is shown the next slide. So where do we believe rates go from here?
Consensus expectations had been hovering around 1.8% to 2% 10-year yield for much of this year, expecting that the economic recovery from the pandemic would lift rates higher. We for some time have believed that the 10 year would remain range bound between 1.25% and 1.75%. In the last month, consensus expectations for the 10 year have adjusted down and today sit at 1.64% by year end. So why have we believe the 10 year would be range bound? Well, post Summer Equity market spike and volatility, Brent is going to cover this more in just a bit, a not insignificant rise in the Delta COVID variant, which we're seeing a deceleration broad economic data post June 30 is likely to, combined with a slower than expected labor market recovery, which Brent covered. And fourth, all-time highs and markets keep bonds in demand as investors worry about the potential end of the market cycle. All of this is keeping bond yields contained in our view.
With these low rates, there is no alternative, Or TINA, as you see here, remains in play. What is TINA? Subdued bond yields continue to drive investors into risk assets. There is no alternative. Does this mean investors should remove fixed income altogether from portfolios? No it remains a critical diversifier and balanced within portfolios. Stick to your long-term plan with the correct volatility profile given your circumstances.
Turning to inflation, as you can see here, it is dramatically higher than where it was just a year ago, it has ticked down ever so slightly, but remains elevated. And if we turn to the next slide, as the chart show, forward looking inflation expectations remain elevated, but do fall as you look forward into the future 3 and 5 years ahead. As you can see here, elevated but lower than the one-year view. And as the chart in the upper left shows here, used cars and trucks are contributing almost two percentage points to the year over year increase in core CPI, which is really incredible. While the pace of used car prices looks to be normalizing lower right, the global chip shortage is worsening. So this might not be over. This story around used car prices.
Some durable inflation, which we're going to show here, could be under way as rents and home prices rise, rents have risen recently up the charts, as you can see here, but the pace is below pre pandemic levels. In a more pronounced data set, home prices in the bottom chart are in sharp increase. The pace of gains will inevitably slow, and real estate prices can even decline, as we were all reminded during the Great Financial Crisis, but certainly much of the recent inflation will be baked into prices going forward. So some of this inflation is going to be sticky.
Additionally, rising inflation has eroded much of the wage gains since last year's recession, as you can see here. This decline in real wages is likely feeding into the decline in consumer confidence that Brent covered. This all feeds into itself. With that, I'll pass it to Brent to discuss where markets might go from here.
Brent: Great, well let's just jump right in and get to our bottom-line views from markets both the rest of this year as well as 2022 and 2023. Let's first let's focus on this year and the next 12 months and let's start with Wall Street consensus. So the 63 firms that make up Wall Street consensus are calling for the S&P 500 from August 23rd which was Monday, all the way through August 23rd of 2022 for the S&P 500 to hit 4921. So that'll be roughly about 11% positive return from last Friday all the way through to August of next year. So what do we believe?
So let's start, first of all, with the end of this year that I'll address beyond on the next slide. So I've been mentioning on the last couple of monthly WebEx's that we could see a little bit of a rough patch in markets later this Summer, early Fall, which would coincide with a normal market seasonality, followed by a re-acceleration into year end. And interestingly, we saw a little bit of that volatility last week to a great market sell off of August, where we lost 1.8% before we went back up. But so our view and what we're thinking about for the end of this year is we're thinking that the S&P 500 could hit 4,700 or higher as possible by the end of the year. Where does that actually come from? Well, markets started this year trading at about 23.1 times forward earnings, and Wall Street analysts are sitting at about $206 per share. So earnings per share times the multiple gets you to about 4756 on the S&P 500 again, we've been calling that for quite some time. Consensus had been a little bit lower, but in the last couple of weeks, consensus have actually come up to our views and beyond. So we're quite happy to see that.
So what do we believe are some of the market drivers and why might this occur? Well, it's continued robust corporate earnings and earnings recovery that is gaining momentum and not losing. As Phil just alluded to, even more negative real rates that's pushing that TINA trade even wider, coupled with broader market breadth and participation than we've seen in previous years. Much more diversified, like I cover on the last call versus only a handful of stocks driving markets much more diffuse this time around. Plus, as Phil also mentioned, a clear timetable on the start of when monetary policy unwind will actually begin. We think that keeps equity markets buoyant not only through the year end, but over the next couple of years. So let's transition and talk about where the market might go over the next two years and do a little bit of a market math.
So instead of broadly speculating on where markets could or should go, I want to focus on the fundamental market math that we believe drives markets. And look, I know there's a lot of numbers on this slide. I'm going to cover all that in a very simple way. But let me start first by decomposing the S&P 500 index into two components. The S&P 500 price is made up of its earnings, which we call earnings per share of the S&P 500 earnings. And then what we call a multiple or sometimes referred to as a PE ratio, which in English is nothing more than what market participants are willing to pay for a dollar of those earnings.
So let's take a look at this table and let's go across the top. Go back for a second, Amy. Across the top of this, you're going to see consensus earnings per share over the next 12 months, 24 months and 36 months. And because the market tends to trade usually a year in advance, think about these columns as today, 2022, and 2023. Down the left-hand side of the table, I'm showing you actual real-life multiples that the S&P 500 has actually traded on in the not too distant past. So let's take a look at that first line where we're talking about today's PE multiple, which is at 21.6 times earnings. If the earnings come through, as analysts expect, as you slide to the right, as we get out to 2023 and the market doesn't get any cheaper or any more expensive, the S&P 500 should trade at about 5200. If you go down to the next line and you think about where the S&P 500 was trading at the beginning of the year at a multiple of about 23.1 times earnings, you can see in that first column in the 12 months that 4756 that are referred to on the previous slide, we think that that's right around where the S&P 500 will finish the year.
But as you slide to the right again, if the next 24- and 36-months earnings actually come through and you do that math, you're going to see that the S&P 500 could trade up as high as 5,600. And then that last line in that top box is what was the S&P 500 trading at right before the technology bubble. Usually as we get late in the cycle, investors tend to pay more and more for a dollar of earnings as growth starts to slow.
And you can see if we were to trade back at sort of that pre technology bubble, you could see the market could trade up as high as 5,900 before this cycle is actually gone. Now, certainly much can and will change over the next couple of years. Analysts could significantly revise earnings estimates. We could have things that slow down corporate earnings growth and profitability, and we will absolutely see volatility along the way over the next couple of years.
But again, if we focus on the fundamentals and we think about where earnings are and where multiples can reasonably trade, we believe that there's a higher likelihood that we could see 5,200 then seeing 3,200. So again, we're optimistic provided that earnings comes through.
So if we transition to the next slide and we think about now that we've covered the big picture, let's talk about the path from here, right. The market continues to rise. We're up almost 20% year to date. And we're up almost 103% from the March 23rd low of last year. And this year has the potential to be like no other for the S&P 500 index. And I'm going to update the slide on the fly because the market finished up positive again yesterday and hit another high. The index closed yesterday at its 50th new high of the year. At this pace, folks, the S&P 500 would set records almost 74 times this year alone, which would come close and almost rival 1995’s record high of 77 new highs in a year, so continued market appreciation.
This next slide is probably one of my favorite slides in the market outlook section, despite the S&P 500 20% run up this year, the index is 7.5% percent cheaper today than it was at the start of this year. So let me say that again. Despite being up 20 percent, the market is 7.5% percent cheaper today than it was at the beginning of the year. Why? Because earnings have been growing faster than the market. But I want to be very, very clear here. What I am not saying is that the market is cheap, actually, far from it. We're trading a good bit above the 25 year and 75-year averages of 16.7 and 15.7 times respectively. What I am saying is that the market has not gotten more expensive than where we started the year, despite this 20% run up, thus providing the market a bit more room for multiples to expand if need be.
So while volatility is certainly picked up in August, it's hit the highest level since January. We knock on wood, have not seen a 5% or greater correction in more than 200 days. The last 5% drawdown occurred all the way back in October, more specifically October 12 through October 30th, we saw a 7.4% correction before we went on to rise 37% from October 31 through last Friday. So what I decided to show you on the bottom right, if you go back one slide, Amy, is from 1928 all the way through last week. What was the average interval as far as trading days between 5%, 10% and 20% drawdowns. And when you look at that first line in all periods, you can see there's roughly 51 days between trading days, between 5% drawdowns, 172 trading days between 10% drawdowns and a whopping 716 trading days between 20% drawdowns. And when you look at where we are today and again, update this on the fly, we're about 204 days without a draw down and about 400 days since a 20% drawdown. And you might think by looking at that, what you're telling me is that we're due for a 5% or 10% correction. Hold on. Look at the secular bull market periods. And you can say we're definitely over the 5% draw down trading days period. We're barely over the period for a 10% correction. But when you think about a more significant drawdown, which will be 20% or greater, we're at least historically a long way from one that's normally occurred.
So, again, one of the reasons why we believe we might see a 5% to 7% drawdown sometime between now and in the early Fall before the market hits higher highs is because of that normal seasonality. So on the next slide, throughout the course of this year, we've seen the S&P 500 bounce or kind of break through its 50-day moving average eight times. We just did it again two weeks ago or actually the beginning of last week. And yet again, we bounced off of that 50-day moving average and are making higher highs. I'm going to update this on the fly, about 4350 is a 50-day moving average right now. It's something that you're going to want to be watching as we get into the early Fall as markets become a little bit more volatile.
On the next slide, over the last 10 years, normal seasonality has seen more negative periods in August and September. Going back over the last 10 years, August has seen 6 out of 10 of those years. August has been negative. Right now, it looks like we might actually break that trend. And September is not that far behind where half of the year's over the last decade, September has posted a negative event. Also, as I covered on last month's WebEx, the three month forward returns of normal seasonality post July month and has seen the least amount of return for the S&P 500 only positive 0.3%, so usually we're getting into the more subdued time of the year with heightened volatility as far as the market goes.
Lastly, longer term, we believe that while market returns over the next couple of years. We think are going to be very good, the remaining part of the next decade, we believe, will prove challenging for stock returns. What we're looking at here is something that was just updated two weeks ago. It's the consensus views of about 39 Wall Street firms that forecast forward looking capital market assumptions just like us. And what that study is pointing to is significantly lower returns over the next decade. More significant, lower than the 10-year average, and the average that we had over the last decade. How much lower, you might say? Well, the expected return for stocks over the full decade for US large cap stocks is only about 5.8%. That is a whopping 4.6% lower per year than the long-term average since 1925 and 16% lower than the decade that just ended.
All of this should point you to make sure that you do two things. First, you should have a financial plan solidly in place and follow it. Number two is make sure you hire a professional team or professional advisor to guide you on the right investment path. It's going to free you from the mix to potentially detrimental emotions you're likely to feel along the way, which quite often feeds back into negative investment decisions. So with that, Amy, I know I can see lots of questions coming through. Why don't we start the Q&A?
Amy: We definitely never have a shortage of questions, especially that come through in the registration process. So we'll start there. Phil, let's let Brent catch his breath for a second. Could you give us some thoughts on the timeline for the Fed to begin reducing its balance sheet? I know you talked and talked about this a little bit, but it's a good enough question. I think it bears repeating.
Phil: Yeah , sure. Just to reiterate, we continue to expect tapering to start in the late fourth quarter of this year. The Fed's thinking is unlikely to be finalized for some time. But it will be interesting to see what conversation comes out of the Jackson Hole economic symposium this week. Our sense is potentially not much, but you never know. They are meeting this week and it could be interesting. In the end, we believe the Fed will begin tapering bond purchases in December most likely, with a long, winding down lasting through at least the end of next year. Of course, the Fed will be dependent and an unforeseen slowdown in coming months, think Delta variant or other causes could drive a change in plans. We saw that in tapering after the Great Financial Crisis, plans were definitely made to be changed during that period and that could be the case moving forward.
On the rate side, market imply pricing shows the first hike end of next year, and the two hikes in 2023. We tend to think the first hike is in the first quarter of 2023. But in either case, rate hikes remain a ways out in our opinion.
Amy: Thank you, Phil. Brent, I've got an interesting question here that I think a lot of us can relate to. Could you give your comments or recommendations for those of us who feel trapped? I believe cash will happen. And I also believe inflation is real. So I'm worried about bonds and where the future is going for a retiring and capital preservation with that in mind for retirement.
Brent: Yep. It's such I could literally spend an entire afternoon talking about that. That question is such a great one. What it's really pointing to is the coming together the crashing of normal human behavioral heuristics and investing in risky stuff. I would say the first thing is just that we don't believe a crash is near, we think and when I define a crash, I'm talking about something more significant, like a 20% or greater correction. We're certainly going to see some volatility, three, five, seven, maybe even 10% along the way to make higher highs. But we don't believe the crash is imminent, at least in the next year or two. But what that really points to is how fundamentally important it is to remove yourself sometimes from your own money.
And I think that's one of the benefits, and I love spending time with our financial planning team and sitting in client meetings because, first of all, I learn something every single time I sit with them. But it makes me feel so much better about my plan, about my life and what I've been able to do. So the first thing I would say is make sure that you have a very comprehensive plan. That's going to help you remove some of the natural fears that you might have about inflation or the stock market. If you have a plan and it's well documented and you're prepared for it, there's a much lower likelihood that you're going to do something detrimental to jeopardize your financial future.
And I know more people that have lost money or put themselves in a bad position because they've been out of the market, then I know people that have been in the market and stuck with that plan. Quite frankly, I don't know anybody that's in a bad position that when they stuck with a plan and didn't try and time markets didn't end up on the better end. And all you have to do is look at the S&P 500 any type of equity market price graph and know that while there's volatility, we've seen nothing but higher highs over the last 300 years.
So, again, to make you feel better and what you're feeling is natural, make sure you sit down with financial planning professionals, get that plan and you're going to feel way better about retiring and making sure that you have the right plan in place to make yourself feel better for the rest of your life, and for your legacy.
Amy: Thank you, Brent. Phil, let's move over to you, kind of piggybacking off with what Brent just said, is it too late to enter the stock market?
Phil: Yeah, it definitely ties into a lot of what Brent said. So I won't be too repetitive. But a question we certainly get a lot. Entry points matter, but it's never too late to consistently invest in the market. It's extremely difficult if it's not possible to know with any certainty where the market is going to go in the near term. What's important is to follow your plan, as Brent said, stay invested and not overreact to market swings. A data point we've used in past webinars, nearly half of the S&P 500 strongest days occurred during a bear market. Another 28% of the market's best days took place in the first two months of a bull market before it was clear a bull market had begun. In other words, it's very difficult to know when the market will see big gains. And if you got scared in a bear market, you took your money out. You're missing out on some of the biggest days in the stock market.
Studies show missing even a small number of the best days in the stock market versus being fully invested can cost you multiple percentage points of annualized return over the long term. Broadly looking over the next 12 months, as Brent discussed, we believe the market is more likely to see further gains on trend. That said, we would not be surprised to see some near-term volatility due to a number of factors. But keep your eye on the longer term, and on the plan.
Amy: Thanks, Phil. How do you see the Delta variant and rising concerns around it for equity growth trajectory for the next 12 months?
Phil: Yeah, so from a Delta standpoint and longer term, it's a very near term when you think about potential rough patch that Brent discussed and we're all tired of talking about it. But the list of any risks COVID needs to be at the top of it. Right as governments potentially scale back reopening, that could have a real impact on corporate earnings, as we saw much of last year, and thereby stock prices. Add to that list the uncertainty around legislation coming out of Washington and some market volatility would not be all that surprising. But as Brent said, we do see strength over the next 12, 24, 36 months longer term.
So it's really about the trend versus near-term volatility. I personally am surprised that we're up in August. It's a historically a tough month with thin volumes, a lot of people that move a lot of money around or on vacation in August. So news and data points like the Delta variant tend to have a bigger impact. So if anything, this market showing that it's more resilient than someone like me would have thought even a few weeks ago.
But in the end, these are near-term concerns. The real question is where are we longer term? As we discussed in the presentation, rate of vaccinations are definitely something to watch and to take really seriously in terms of hospitalizations and infections. Hopefully this is transitory. Hopefully we're in a better place and course to come, but we will see from the health perspective.
Amy: Thank you, Phil. Brent, I've got a couple of questions around the rebalancing portfolios and kind of our process, would you mind hitting that one for us?
Brent: Sure so at the core of what we do, so we develop a forward-looking capital market assumptions every single quarter for both a 3 year and a 10 year for look ahead. Every single quarter, we're re optimizing our clients' portfolios to make sure that we're reflecting what might be coming down the pike. Now, that doesn't mean that we change portfolios every single quarter. We're incredibly mindful of trading and taxes and not moving around the portfolio just because, you know, all of our work says x. We're very mindful of that. So we're trying to make sure that we can, number one, improve the forward expected return for the portfolio for a given amount of risk, or if we're able to significantly de-risk the portfolio for a given level of return. And if we have any more than a handful of asset classes that have 3% or more change intra-portfolios, then we tend to change our asset allocation.
Now, what I will say is that every client's goals and objectives are unique. And our portfolio strategies team works with clients to systematically rebalance portfolios. Let's say there's a big infusion of cash or cash might have come out of the portfolio. So we might also do something as it relates to a market downturn and tax laws harvesting. So there's a number of things that might occur that might cause transactions in your portfolio or cause us as a group to rebalance your portfolios.
Amy: How do you tie-in the cost of inflation with that process?
Brent: Yeah, it's I mean, if I had a nickel for every time the word inflation was mentioned in a call or a client meeting, it's been a lot. We covered this on the May WebEx and there was a really good slide that we had there. At the end of the day, the linear equation for solving portfolios for inflation is nominal portfolio reach our nominal portfolio returns minus fees, minus taxes, minus realized inflation is what you all get to keep in your pocket. So at the end of the day, one of the more effective ways to combat the effects of inflation, unfortunately, is through higher nominal portfolio returns. With the slide that you're looking at right here again, while the next couple of years we think are going to be pretty good, the full decade might be a little bit challenging relative to history and relative to the decade that just ended. It can be dangerous and a fool's errand to automatically look to various products or things that might solve your ills all in one fell swoop, whether that's tips or treasury inflation protected securities or things along those lines. What we look at when we look at the companies that we actually invest in, the vast majority of those companies have been very, very effective at passing through higher costs, higher input costs and inflation through to their end consumer. I showed you the slide on sales. I showed you that on gross income, on earnings and margins, Corporations are the best hedge for inflation.
Now, again, like Phil said, you can't just go out there just randomly buy lots of stocks and that's your solution. You need to have a financial plan and you need to have the right balance of stocks and risk managing assets or fixed income in your portfolio to make sure that that’s congruent to your goals and objectives. There is no one magic bullet for inflation, but it's absolutely part of everything that we do, not just now because inflation being talked about, but all the time we're thinking about inflation.
Amy: Thank you, Brent. Just one last question over to Phil, I think the Fed is wrong, that inflation is transitory. And are you expecting any kind of changes in your favorite restaurants or I'm sorry, I misread that. What do you think is going on with the Fed and from an inflationary transitory perspective?
Phil: Yeah, I think I get the gist. I mean, certainly the inflation we are seeing will be durable. What we discussed in the presentation, rents and home prices as two examples. When the Fed describes inflation as transitory, they're referencing the piece of increasing inflation that the pace of inflation will come in, not the idea that inflation will turn outright negative. So if prices increase in a given good, depending on the good, it might stay there. The pace of increase is what they expect to decline.
Now, much of the inflation we are seeing today, which is on the heels of years of extremely muted inflation, we do think to that point will be baked into prices going forward. We are still an economy in an economy with shortages of goods, such as the ship shortage. As we mentioned, shortages in labor, which we discussed as well. Both are driving inflation when you think about ships and labor shortages, but neither are likely to be permanent phenomenon. Eventually, these things, the market is going to find its equilibrium. For now, year over year inflation data is still compared to an economy that was still highly restrained last year at this time due to the pandemic. The real question is, where are we a few quarters from now, next Spring and Summer, for example, when we're comparing to now.
If inflation at that point is still running at the current levels, the trade story argument will look much more suspect in our view. We're seeing some near-term positive indications, lumber prices, which were a really hot topic a few months ago. We want to talk about something that came up in every meeting, lumber prices. Well, they all come up at meetings anymore because they've fallen 70% from the May peak, lumber prices have, and are back to levels we saw in February of 2020 before the pandemic shut down the US economy. So not all prices are just going up in a straight line. We are seeing moderation here and there. But really, when the Fed says transitory, they don't mean a month. It is multiple quarters. And the real question is where are we a couple quarters into next year? And then time will tell.
Amy: Thank you, Phil. Brent, let's wrap up with this one, if you don't mind, and it's a question on ESG investing and their strategies around it. How does this way into the objective of providing return for investors?
Brent: Yeah, it's a great question. What ESG or environmental, social, and governance criteria is absolutely here to stay, whether that's at a corporate reporting level, whether that's from an asset management perspective like us, from an investment perspective, it's absolutely here to stay. I think it's important to understand and balance that any time you constrain a universe, let's just say a universe of stocks and say constrain that to companies that do good or less harm, however you feel that you want to define it, we define it in a very specific way to take you long to get it to the detail that we have to go into the call. Any time you constrain a universe, you run the potential risk of not performing in a way that you think, and certainly ESG has done well. She does have a little bit of a growth feel to it.
And obviously growth stocks have done really well in the last several years. Whether that will continue in the future. Time will tell. But ultimately, we're very much focused on ESG. We manage portfolios that are available in the ESG sense. We definitely think it's here to stay, but you have to go into it with eyes wide open and be very educated. And certainly if anyone's interested, we'd love to educate you as much as we possibly can on ESG. But again, I think it's certainly here to stay.
Amy: Brent, Phil, thank you so much, as always, for answering questions for us. We're a little actually a little bit over time, so I'll go ahead and wrap things up. I want to thank everyone for being on the call today. As I mentioned at the beginning of the webinar, we’ll automatically send you the replay, and it will also be posted on firstcitizens.com/wealth. If your question wasn't answered, please reach out to your First Citizens partner. And thank you again for being with us and enjoy the rest of your day.
Brent: Thanks everyone.
Phil: Thank you.
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