Market Outlook · November 18, 2021

Making Sense: November Highlights

Brent Ciliano

CFA | SVP, Chief Investment Officer

Phillip Neuhart

SVP, Manager of Institutional Portfolio Strategy

Are we back in the 1970s? Here's why the Fed needs to raise rates.

The Fed and markets disagree on timing and number of rate hikes. The Fed is looking to make seven or eight rate hikes for an effective federal funds rate of 1.75% by the end of 2024. The markets want a slightly more aggressive timetable for rate hikes and are looking for an effective federal funds rate of 1.52%. This puts the Fed in a precarious situation because it needs to raise rates as the policy rate adjusted for inflation is the most negative since World War II.

The real federal funds rate is lower today than at any point in the 1970s. We believe our baseline forecast is one rate hike in 2022, likely in Q4—though this is very much predicated on the magnitude and direction of inflation (which we believe peaks in December 2021 to January 2022). If inflation doesn't peak then and continues to run hot into first quarter of 2022, then we expect two hikes in 2022.

How have stocks done in a rising rate environment?

Over the last 30 years, US stocks have been positive during all seven rising rate cycles with an average cycle return of over 17%. Historically, rising bond yields haven't negatively impacted stock returns.

What might happen with fixed income rates?

Consensus expectations has the 10-year at 1.65% by year-end 2021, and 2.03% at year-end 2022.

What do we believe? The 10-year will remain range-bound between 1.75% and 1.25% at least through the first half of 2022 before breaking through 1.75% around mid-year 2022.

Inflation: Have shortages turned a corner?

We're seeing good and not-so-good signs on the inflation front, which we cover in detail on this month's webinar.

Four primary bottlenecks we believe are present are products, transportation, labor and energy. Ultimately, we believe we're seeing a peak bottleneck in three of these four cases. The energy bottleneck remains a key issue.

Where do markets go from here?

Wall Street consensus 12-month forward price target for the S&P 500 is 5,142.95 as of November 12, or around 10.6% return from November 11, 2021's market close.

In May, we estimated the S&P 500 may see 4,700 (or higher) by year-end. On November 8, the S&P 500 closed at 4,701.70 marking the 65th new high in 2021—only 12 new highs shy of the 1995 record of 77. With a month and a half to go, the 2022 year-end S&P 500 price target is 4,900 as earning growth moderates, operating margins fall from record highs, and inflation and tax hikes take a bite.

We believe the S&P 500 can potentially achieve 5,300 or greater over the next two or more years, but the market's easy gains are likely behind us with much volatility and choppiness going forward.

Why? Learn more about our thoughts on where the market goes from here and other topics on the full replay.

View Webinar

Making Sense: A Market Update

Watch the replay of the November 17 webinar, where Brent Ciliano and Phillip Neuhart discuss what's going on in the markets and economy.

Watch the November 17 Making Sense Webinar

Amy: Hello, everyone. Welcome to the First Citizens Wealth Management webinar series, Making Sense, where Chief Investment Officer Brent Ciliano and Manager of Institutional Portfolio Strategy Phillip Neuhart help you make sense of what's going on in the markets and the economy. I'm Amy Thomas, a Delivery Specialist with First Citizens Bank. We're excited to have you with us today. We didn't meet in October, so we've got a lot of ground to cover today. While everyone's logging in, let's go through a couple of housekeeping items.

First, this webinar is being recorded and we will send you a replay following the conference. Secondly, this webinar is interactive. We want to hear from you and address your concerns. If you submitted a question during the registration process, your question is in queue. If you'd like to ask a question during this discussion, please use the Q&A or the chat feature to submit your question. 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, so if you have a specific question about your financial plan or we don't get to answer your question during today's webinar, please reach out to your First Citizens Partner.

As a reminder, the information you're about to hear are the views and opinions of First Citizens Bank and are for educational purposes only. If you have any concerns, please reach out to your First Citizens Relationship Manager. Brent, it's been a while since we've all been together. I know you have a lot to share, so I will kick it over to you to get us going.

Brent: Great. Well thank you, Amy, and good afternoon, everyone. I hope all of you are well and getting ready for the Thanksgiving holiday next week. It's hard to believe that it's here already. So before we jump into what we're going to cover on today's call, I wanted to let you know that Phil and I will be covering our 2022 and beyond market outlook on Wednesday, December 15th. We'll deep dive into where we think markets go in 2022 and 2023, as well as what to expect in the decade ahead, and that remainder of the decade that ends 2030. That webinar will be in place of our normal December Making Sense updates. So please make sure you put that on the calendar because you won't want to miss it.

So for today's call, Phil and I are going to compartmentalize the first four topics on growth, the labor market, the consumer and corporate earnings and profitability into only seven slides because we really want to focus on the path forward for inflation and interest rates. Additionally, I'll touch upon where we think the market goes from here as we enter the last six weeks of the year, plus we'll discuss how long this equity market cycle could last and how high the market may go. So with that, Phil, why don't you kick us off?

Phil: Great, thank you, Brent, and good morning or afternoon to everyone on the line. In our last webinar during September, growth expectations for this year and next, were 5.9 and 4.2 percent, respectively. Now those growth numbers, as you can see on this slide, are 5.5 and 3.9 percent, respectively, so they've come down. So while economists expect to see above trend growth this year into 2022, economic growth estimates and activity are slowing in the US. On the other hand, 2023 estimates improved slightly since we last met, but growth is still below the long-term trend of 2.8% Turn to the next slide. US real GDP growth slowed considerably in the third quarter, though it was still positive at a 2% annualized rate, but well below already lowered expectations. Consumer spending contributed just over 1% of the 2% total growth, while non-residential fixed investment contributed only 0.2%.

We think consumer spending the motor vehicle component subtracted a large 2.4% points from GDP, which is just incredible. Supply chain issues have been key in this sector as many of you are well aware. Inflation also hurt real GDP growth. Nominal GDP, which, unlike real GDP is not adjusted for inflation, was a whopping 7.8% So compare that to the 2% that you could see just the impact inflation had on real growth. Bottom line given the makeup of this GDP report, we continue to expect US economic growth to rebound in coming quarters. Demand remains solid. Our only hesitation on calling this the peak in the stagflation scare is the current rise in energy prices that could persist through the winter months.

Let's turn to the labor market. 531,000 jobs were added in October, plus another great news job numbers were revised up for August and September. However, the all-important labor force participation rate did not improve. At this point, the US labor force is 3 million below its pre-pandemic peak. Still, we've come an incredibly long way. So far, the economy has added back 18.2 million jobs of the 22.4 million lost during the pandemic. The current three-month rate of job gains is 442,000, which has us returning to the pre-COVID trend sometime in 2023. So how is the consumer doing? In some, as you could see here, their financial picture is pretty good. Net worth is an all-time high. Debt payments as a percentage of disposable income is sitting near the lowest levels in more than 50 years, and the current 7.5% savings rate is above the 6.8% long term average. The savings rate is off the extreme highs of last year as consumers received federal relief checks, but that too is healthy as consumers are providing support to the economy through their spending. We are a consumer economy.

As you can see in the bottom chart, wages are growing at the fastest rate in more than 20 years, but the downside here is real wage growth is currently negative after adjusting for inflation. Even given this financial backdrop, consumer sentiment is at the lowest level since 2011. Consumers are citing inflation bottlenecks. The political environment is negatively impacting their sentiment. Yet so far, consumer spending has remained strong for both goods and services. Just yesterday, October retail sales were released and surprised to the upside. The consumer might not like the news headlines, but that has yet to impact their spending materially.

So let's turn to earnings. With 92% of companies having reported third quarter earnings, 81% of companies are beating earnings estimates thus far. The third quarter's estimated earnings growth rate for the S&P 500 is over 39% This number was 27% on September 30th. Many companies have outperformed estimates dramatically. The unusually high growth rate is due to a combination of higher earnings in third quarter 21 and an easier comparison to lower earnings last year due to the negative impacts of COVID-19 in 2020. For the full year 2021, we are pacing an earnings increase of over 44% and a revenue increase of over 15% So both top and bottom-line results have been excellent, and the surprise factor is double digits for the sixth quarter in a row, as you can see the lower right. This suggests that analysts are consistently underestimating earnings for companies, and companies are outperforming those estimates.

Since we're close to wrapping up 2021, let's talk a bit more about 2022 expectations. As more strategists publish their earnings estimates for next year and beyond, the bias continues to be higher. After record earnings this year, estimates rise for both 2022 and 2023. As Brent will discuss, these elevated forecasts are central to our equity market thesis, but more on that in a moment. On the bottom right, despite all the concerns around inflation pressures potentially eating into corporate margins of profitability, the S&P 500 is estimated next 12-month operating margin remains at a very high level versus history, as you could see here. None of these statistics mean there are not risks to the outlook. Key risks include shortages of materials and labor, which are driving up costs, along with continued uncertainty around the corporate tax environment going forward. So not a clear picture, but certainly a hopeful picture. With that, I'll pass it to Brent to discuss interest rates.

Brent: Great, well thanks, Phil. The Fed met earlier this month to discuss plans around reducing their open market purchases of bonds. And remember folks, the Fed has been buying $120 billion a month of treasuries and mortgage-backed securities as part of their broader monetary policy program. That, combined with a September release of the Dot Plot, really gives market participants the Fed's perspective on the course of where monetary policy goes from here. Long story short, the Fed and the markets disagree on not only the timing, but also the level of rate hikes from here. So let me cut to the chase and talk about what we believe. The Fed for some time has been overtly deliberate in both their words and their actions, and we think that that's going to continue for some time. Our baseline forecast is that the Fed hikes rates one time in 2022 likely in Q3 or Q4, though this is very much dependent on the path of inflation and the magnitude of inflation.

We believe and we'll get to it in just a minute that inflation might peak next month, maybe January of 2022. If it doesn't, and inflation continues to run hot into the first quarter of next year, we then believe the Fed will have to hike two times. One in July and then another in the third or fourth quarter. Probably beyond that, we think the Fed hikes three times in 2023 and then only two times in 2024 as US growth starts to fundamentally decelerate as Phil highlighted on earlier slide and the Fed putting the brakes on the economy, those two things don't mesh. Ultimately, we think the terminal value for Fed funds is roughly about 1 and a half percent when all is said and done. And the Fed is in a really precarious position because real Fed funds, in essence, the Fed funds rate adjusted for inflation is at the lowest level post-World War II. So worse than any time in the hyperinflation that we saw in the 70s. So when you think about the need to raise interest rates, it's something that the Fed very much has on their minds as well as market participants.

So if we turn now to the Treasury yield curve top left, the 10-year Treasury has been fundamentally range bound between 125 and 175 all the way since March, on the bottom right. After the Fed released its plot and started to talk about future interest rate hikes in 2022, 2023 and 2024. The yield curve started to steepen, but as economic growth started to decelerate in the US, inflation started to rear its head. The yield curve started to flatten back down again. So what do we believe and where do we believe rates go from here? Let's first start with consensus. Consensus has the 10-year Treasury at 165 by the end of this year and 203 by the end of next year. We believe, and we believe for some time that the 10 year will be range bound between 125 and 175, at least through the first half of next year. Once we get through the first half of next year, we believe that the 10-year Treasury will break through that 175 mark as market participants, you know, factor in the end of Fed tapering and the potential for interest rates rising from there.

Ultimately, as I said in the last slide, the path forward of inflation will be the ultimate arbiter of that. A Tina, or an acronym for there is no alternative, remains solidly in place, and rates today are the most negative they've been in the last 40 years, you have to go all the way back to 1979 to find a time where the 10 year was more negative than it is today. So how long do we think Tina will stick around on the bottom right? You can see market implied pricing and expectations has Tina sticking around until the first quarter of 2025. So negative real rates on both cash and global fixed income has and will likely continue to be the wind behind the back of global risk assets as really the only game in town where investors can earn a positive real rate of return on their investments, at least for now.

Phil and I have covered this slide on several monthly calls. As a reminder, over the last seven rising rate cycles over the last 30 years, going all the way back to 1990, stocks have posted a positive return in 100% of those events and have had a cycle average return of 17% So despite what tends to get mentioned in the financial news media, rising bond yields, at least historically, have not negatively impacted stock returns. So, Phil, why don't I turn it back over to you and you can kick us off on inflation?

Phil: Yeah, let's jump right in on page 17. So as everyone on this call is well aware, inflation is running well above target. In October, consumer prices as measured by the CPI rose 6.2%, and core prices, which exclude food and energy, rose 4.6 percent, both above expectations and the highest levels since 1990. It's not just a US thing. 58 of 75 countries have one year CPI above their 10-year average. This is the highest number of countries on record. So if we dig into the October report, price increases were widespread across goods, transportation, shelter, labor, energy, you name it. Energy and COVID related items explain more than half of the increase. As you could see here, the impact of supply chain bottlenecks was clear. Core goods prices rose 1% month on month. In a month, they rose one percent, led by new and used cars. The price increase in services categories were also broad based, suggesting the labor shortages and rapid wage growth may be seeping into consumer prices. Reopening categories were mixed with gains in autos, hotels and restaurants, but a decline in airfares. As the chart shows, the consensus expects inflation to remain elevated in coming months, but for the pace to slow modestly as we enter 2022.

The latest data point show that in the one year ahead, inflation is expected to be 5.7%, which is the highest reading on record. However, the three year ahead data that shows the second consecutive month of 4.2% Perhaps this is signaling that inflation is likely to settle 1% or more higher overall compared to the pre-COVID period. In the next two sections, Brent and I are going to cover the good and bad signs we are seeing on the inflation front. There are four primary bottlenecks we are monitoring. Products, think of chips, semiconductors and autos. Transportation, think of ports and school buses. Labor and energy. Bottom line. We believe we are seeing a peak bottleneck story in three of these four, not the bottlenecks are improving, but we're at the peak in three of these four cases. While the energy bottleneck remains a key issue heading into the winter months.

So let's jump into inflation, the good or maybe we should call it the slightly better news. I'm not sure if it's good, but slightly better. So let's jump right in. Certain inventory shortages might be turning the corner. Auto inventories are still extremely tight, as you could see here, but we might be seeing a slight improvement. Similarly, auto sales are still depressed, but have improved very slightly. Still low. Very slight improvement. And as you could see in the headlines on the lower left, both semiconductor and auto companies are providing slightly better or at least less draconian guidance, which is good to see.

Certain supply issues appear to be abating as well, lumber prices are again improving, as you can see in the upper left, as is the supply of homes for sale, which is improving in the upper right chart. We're even seeing a modest improvement in the number of containers clogging up the Port of Long Beach, which is good to see. And while still very elevated, the cost of container shipments has declined slightly, as you could see in the bottom right. Very elevated, but slight improvement. Similarly, small businesses are reporting a slight improvement in shortages. Also, many businesses have been over ordering and stockpiling, as you can see in the inventory data on the bottom right, where possible. So with that should put downward pressure on prices in the future as these stockpiles build and need to be sold down the road.

So is small business labor turning the corner? The number of small businesses with few or no qualified applicants recently declined, but remains historically elevated, as you could see in the upper chart. Also, businesses worried about the quality of labor is starting to fall. As with the previous slide, these are slight improvements, but improvements nonetheless. So more on the labor market, as we have already stated, the labor market remains extremely tight, as you can see in the upper left, those not in the labor force remain well above the pre-pandemic level. That's the blue line in that chart. In the same chart, the red line 6 million people are not working, not in the labor force, but say they want a job. These individuals are not counted as unemployed because they were not actively looking for work or were unable to take a job. But on the same time, we have 10.4 million job openings, so it's about growing the labor force so supply and demand are more in line. It will not be easy. There was a recent study out of the St Louis Fed which said, quote, “As of August 2021, there were slightly over three million excess retirements due to COVID-19, which is more than half of the 5.25 million people who left the labor force from the beginning of the pandemic to the second quarter of 2021." So if 3 million workers are not coming back, the US labor market is even tighter than it looks. With that, I'll pass it to Brent to discuss the not so good side of inflation.

Brent: Yeah, thanks Phil. I don't know how I drew the short end of the stick-on today's presentation to cover the not so good. But let's talk about optimism and prices and still have a long way to go. What continues to be a fundamental issue is how both consumers and small business owners feel about the current and future environment. As you can see in the top left, after a little bit of modest improvement, small business owners continue to be concerned about the future and on the bottom right the number of small businesses citing inflation as the number one problem is actually rising after subsiding a little bit. And it's important to remember, though, that confidence readings tend to lag changes and the real economy by several months, so it's quite likely that we'll see a change or turn in the economy we feel before we really see that reflected in the confidence data. On the top left, you can see the percentage of small businesses planning to raise prices is still increasing and increasing at a pretty significant rate. And as Phil just alluded to, the percentage of small businesses planning to raise worker pay is still increasing in this incredibly tight labor market.

The next slide, when you think about, you know, home prices, this is either a good slide or a bad slide, depending on whether you're a seller or a buyer. Top left US home prices are sitting at the highest level in more than 20 years, but on the bottom right, you can kind of see the Lochness monsters head kind of peeking down a little bit. And home prices might have peaked in October. And as Phil mentioned, with a slight rise in mortgage rates and increase in fundamental supply, maybe we've hit the peak in home prices, though, when we look at history, there's usually anywhere between an 18-to-24-month lag in the subsequent decrease in home prices once you sort of get to the top. So how long might this be a problem? As Phil mentioned earlier, there have been four bottlenecks we've been monitoring the supply of product, transportation, labor and energy. None of these today are even close to being resolved. But as Phil said, in three of four cases, we believe we're seeing peak bottleneck. And again, energy to me remains the biggest wild card as we head into the winter. So how long might this continue to be a problem?

Let's start first with consensus, as you can see in the chart. Consensus believes that we will head back towards the Fed's 2% target a little bit above that by fourth quarter of 2023. We actually believe that we're going to see material improvements across these four areas beginning at the first half of next year at the end of the first half of next year, with continued improvement into the second half of 2022 and 2023. But folks, it will take several years, in our opinion, for prices to normalize back to pre-COVID levels and in some cases, prices may never go back to pre-COVID trends. But longer term, though, remember that structural forces like technological advancements, manufacturing, innovation, artificial intelligence are all long-term disinflationary forces as they make things cheaper and easier to manufacture and implement. Thus, the broader longer-term trend and level for inflation is lower, not higher because of that. So again, temporary issues, but we think that they'll abate. It's going to get better next year, probably even better in 2023. Longer term disinflation, not inflation.

So let's talk about where markets go from here. And remember, I'm going to get and Phil's going to get really deep on December 15th, so we're going to hit this, I think, rather quickly. But let's jump into where equities are today and year to date, significantly above 26%, 26.7% return through last night for the S&P 500, just stellar returns year to date. On the right-hand chart, you can see, despite that stellar return, the S&P 500 is 5.4% cheaper today versus where we started the year. So let me be very clear, I am absolutely not saying that the stock market is cheap. Quite the contrary, it's quite expensive. But what I am saying is that earnings so far this year have grown faster, as Phil highlighted earlier, than the price of the stock market, hence multiple contraction. And we are cheaper today than January 2nd of this year. Counter to intuition of many investors, this 26% stellar return is not in and of itself a good reason to expect weak returns in 2022. And since 1900 the S&P 500 has generated an average 12 month rolling return of about 10%

Returns have actually averaged slightly better than 11% per annum following periods of 12-month gains exceeding 20% So let's please all cross our fingers and hope that historical trend plays out next year. So the stock returns this year are much, much more balanced than they were last year. If you remember, last year, the top 10 stocks in the S&P 500 returned an incredible 43% The bottom 490 stocks returned a Meager 3% Yet the S&P 500 put up an 18.4% gain in 2020. 2022 is seeing a lot more breadth and diversification within the S&P 500. Case in point on that bottom right-hand chart. The average stock is outperforming the capital weighted index year to date by over 2%. So much broader diversification in the index this year than last year. So with about six weeks left in the year, how might we end 2021. Well, history could potentially be a good guide. What we're looking at here is the average of every November and December from 1950 through last year, and the S&P 500 has historically chopped and trended sideways for the first three weeks of November. But after the third week of November, historically, it's been pretty much a straight shot up from there, and we've historically seen an average 3% additional return for the S&P 500 on average, from the third week of November to year end. So again, if that were to happen and we do move 3% higher, that means that the S&P 500 would be trading North of 4,800 which is again significantly above the forecast that we had all the way back in May of 4,700.

So again, fingers crossed, and let's hope that history repeats. After hearing what Phil and I just covered on inflation, a question likely on many of your minds is what might be a good portfolio solution to help me combat the effects of inflation on portfolio returns. But before I jump into that, let's remind ourselves what the inflation equation is for your portfolio. And let's look at this picture and let's go through this equation. Nominal portfolio returns minus fees and transaction costs minus taxes minus realized inflation is what all of you get to keep in your pocket, after all is said and done. So the only true hedge to inflation is higher nominal portfolio returns, and there is rarely ever a magic bullet to solve the equation for that. But let's look at history, and let's go to the next slide. The best hedge for inflation, at least historically outside of private investments, has been equities. And despite certain asset classes performing well during temporary periods of higher expected and/or realized inflation, I think commodities, tips, gold. Those asset classes have struggled to generate positive real returns over medium to long term investment horizons, and while in times of inflation, they've historically tended to outperform traditional asset classes. Those periods have proved both sporadic and short lived, very, very inconsistent. So you have to get the timing right on the way in and the timing on the way out, which is incredibly hard to do, not only for those asset classes, but for the market at all. So ultimately, we believe that equities, and if I broaden out the chart or the bar chart here that you see to go beyond US equities and look at international equities, we believe that is the much better asset class to generate real returns in your portfolio and to protect your portfolio against the ravages of inflation. And again, remember, we're always dynamically adjusting your portfolio every single quarter to be reflective of what's coming down the pike. So this is always something that's at the top of our mind, not just because inflation happens to be the hot buzzword or topic of the day.

So let's talk about a little bit of market math and how high the S&P 500 can go not only for the next couple of years, but for the full cycle. I showed you this market math, I think two WebEx’s ago. So let me just kind of get into what we're looking at here. The price of the S&P 500 is made up of two simple things, the aggregate earnings per share for the companies that make up that basket of stocks times the multiple that investors are willing to pay for that dollar of earnings. So in essence, that multiple or P/E ratio times earnings per share gives me the price of the stock market. So across the top, we're looking at the consensus forward earnings per share for the S&P 500 12, 24 and 36 months. And because remember, the market is always an expectation pricing mechanism and bids itself up or down in advance of things to come. You could almost put 2022 over the 24 months column and 2023 over the 36 months column. So if we look at that first sort of line out where you see that green box, if the market doesn't get any cheaper or more expensive and basically just stays at today's multiple, which is 21.9 times earnings, you can see earnings comes through at $224 per share. And again, much can change can happen over the course of a year. That puts the market price at about 4,900 by the end of 2022.

But as you can see, our belief is that gains in the S&P 500 will moderate rather significantly in 2022 as earnings growth decelerates, margins come back down to earth, and inflation and corporate taxes potentially take a bite out of corporate earnings and profitability. Again, our expectation for 2022 is about 4,900 which is about a 4% return for the year for the S&P 500. But as we widen out, you're going to see in 2023 expectations for earnings pick up, and we're looking at a 9% to 10% acceleration over 2022 levels for earnings. If again, the market doesn't get any cheaper or more expensive, we basically stay kind of flattish from a multiple perspective that puts us at over 5,300 by the end of 2023 if earnings just come through and again, much can and will change over the course of the next 12 or 24 months. But again, normally what we've seen in many cycles is that as we get closer to the end of a secular bull market, which we believe we are getting closer to the end and again, tune in to December 15th so I actually tell you exactly when that's going to happen, in our opinion. So make sure you dial in for that. You normally have P/E multiples melting up where people pay more and more and more for the same dollar of earnings as earnings growth decelerates, economic growth decelerates and multiples just melt up.

If we were to just get back to where the multiple was on January 2nd of this year, a 23.1 times, that means and again, earnings come through, that means that we can see in excess of 5,600 on the S&P 500 by the end of 2023. But again, much can and will change. So let's bring this home and talk about our bottom-line market views on the next slide. Again, we're going to cover a lot of this on the 15th of December. But let's first start with Wall Street consensus. From Friday of last week until November 12th of next year, Wall Street consensus is calling for about 5143 on the S&P 500, which is a roughly 11% gain from last Friday 12 months forward. Back in May, we believe that the S&P 500 would achieve 4,700 or higher that was achieved on November 8th of this month. There's still a lot left to go before this year is up, but on that slide that I showed you looking at the last six weeks of the year again, fingers crossed that history repeats. If that were to come through, you might be seeing 4,800 or higher on the S&P 500 as we ring in the new year. But what we do expect, as we move beyond that into 2022 is much, much more volatility.

We're likely to see rates, currency, equity volatility significantly more heightened in 2022 than we saw in 2021 which was pretty much a straight shot up. I just mentioned on the previous slide, we believe over the full market cycle, we're likely to see 5,300 or greater. But in our belief, the market's easy gains are likely behind us and we're likely to see a lot more market shop, a lot more volatility going forward. And again, bottom line, as long as rates remain negative in real terms, valuations we believe can remain high and the market direction should remain roughly on solid footing. But again, please make sure that you keep tuning in because much can and will change between now and the end of 2023. So with that, Amy, I see lots of questions in the queue. Why don't I turn it back to you to cover Q&A?

Amy: Thank you, Brent, thank you, Phil, for going through all of that information. We do have several questions that we've already received. Brent, the first one is to you with so much legislation and going through Congress right now, there's a few around climate change and proposals around that. With that proposal in place, do you see an increase in ESG portfolio investing?

Brent: Well, that's a fantastic question. The answer is yes, though I would say there's a lot that still needs to be done, both on the asset management side. But also on the company reporting side, and I think what would probably come from additional legislation is more and more companies reporting environmental, social and governance like footnotes and information in their financial statements, hence making it easier for market participants to do, in fact, that. But I think ultimately ESG has lots of definitions for many investors, but ultimately, I do believe legislation will push more and more companies, at least in the United states, to be reporting along ESG lines, which I think is a great thing. I think we're going to have to do more outside of the United States, and especially in emerging markets to push more and more companies to report down those lines. But the quick answer is yes, I do believe that will be the case, Amy.

Amy: Thank you, Brent. Phil, moving on, we've covered a lot on inflation, the good and the bad. Could you give our listeners a takeaway on whether or not the consensus view is that inflation is transitory or is it becoming permanent?

Phil: Yeah, I think at the highest level, it's a little bit of both and really depends how you define all these words. I mean, clearly, inflation will be elevated for some time as bottlenecks persist. We discussed a lot of the bottlenecks that we're seeing in the marketplace. Even the Fed has raised its forecasts and its September numbers and expects inflation to run above its 2% target for several years. And people think the Fed is behind the ball. They're saying that it's going to be above target. Now that is only modestly above target in our ears, but still elevated. After years of inflation running below target, the Fed appears comfortable with running slightly above target for some time after being below target really for the last cycle or two.

As Brent pointed out, consensus believes inflation will moderate in coming quarters and will eventually be closer to the Fed's 2% target around the end of 2023. So that's a long time right, and I think it's something it's going to be here for a little while. We believe material improvement will begin in the middle of next year and some of that’s just math. I mean, inflation's measured year on year. When you're looking at something like the December print of inflation, which is released in January. So we won't be talking about too, January, where you're comparing to December of last year in which much of the US and globe is still fairly shut down. So some of it is as you move into next year, comparing to this year, it's not going to be nearly as stark as comparing to shut down economies. So we think there's continued improvement as you starting in the first half of the year or by middle of the year, let's say back half of 2022 continued improvement in its 2023.

But as Brent pointed out, we think it will take several years for inflation to reach pre-COVID levels. So just because it's falling from these extreme highs does not mean it just dropped to 2% and everyone's happy. In certain cases, prices may, may never go back to pre-COVID trends. But as Brent mentioned longer term, there are structural forces that remain in place just as they have in the last couple of economic cycles and will be disinflationary in our view as we look ahead beyond the medium term. So yeah, here to stay at least elevated first target but the current extremes are very unlikely to see over a multiyear period.

Brent: And Amy, if I could comment on that, I want to bring up a question that another listener asked on the last WebEx, and this bifurcation between big companies and small and medium sized companies. We believe that small and medium sized businesses, and I think it was very, very clear in the NFIB survey data that small and medium sized businesses might unfortunately suffer a little bit longer than some of the bigger companies that have broader economies of scale, potentially better pricing power and potentially better distribution and supply channels, so I think it's going to be by a bifurcated recovery between big businesses and small, medium sized businesses. So Phil and I are going to try and do our level best to make sure that every time we come and talk to you folks about this, that we'll bifurcate that conversation and make sure that we show you the difference between what's going on with S&P 500 type companies and what's going on in small and medium sized businesses, as well as what's going on regionally.

Amy: Thank you for that, Brent, I appreciate that. Let's stick with you along the lines of inflation, which is the hot topic today, for sure. What allocation strategies in light of near-term inflation are you and your team taking on?

Brent: Yeah, it's something that we've been looking at for quite some time because and we'll touch upon this on the December 15 call. We believe expected returns over the next decade are going to be incredibly low. And then on top of it, inflation, even if it comes back down, as Phil says, we'll be running slightly hotter than what we saw over the 11 years pre-pandemic, which was 1.6% So lower expected returns, higher inflation, lower nominal or sorry, lower real returns for client portfolios. So we are constantly looking at what we can do in the context of our asset allocation to make sure that we get our clients the highest nominal rates of returns after fees, after taxes and then ultimately after inflation. Like I said, there is no magic bullet. Right? Commodities, tips, gold, very fleeting. Very sporadic. And yes, commodity prices have popped up. Very volatile. I will tell you the difference between what you see with spot prices and commodities and what you can actually invest in the futures market are apples. They're not even apples and oranges. They're apples and kumquats, right? You're not you're not even getting the same thing. So you just have to be very careful what you pull in and pull out in the portfolio.

You also have to remember we've had ridiculously high nominal returns for the last several years and the last decade. I think Phil talked about this on the last call. The decade ended returns for the equity market, are 14% for US stocks, about 13% for international stocks and about 5% for fixed income. So as we start geometrically linking this together, we still think portfolio returns will eke out a very positive real rate of return. But understand, as we're optimizing your portfolios, there will be things coming in and out. Things like infrastructure, things like wreaths, things like international small cap, non-directional alternative things that we will be putting in the portfolio to make sure that we're getting you not only the best nominal and real returns, but also managing the experience along the way. So that you can have the most smooth experience as we can possibly muster up so that as you're generating these returns, that the right is potentially smoother, though again, if expected, returns are going to be lower in the future. There's things in the portfolio that we're going to have to do beyond what was a lay up in the previous decade. So again, more to come. Stay tight with us and we'll make sure to keep updating you on the portfolio changes as they arise.

Amy: Brent, let's change gears a little bit and switch over to the Fed and the rates possibly going up in the near future. What if we talked about this a little bit during your presentation, but could you give our folks a take away as far as effects on equities with the likely Fed increase?

Brent: Yeah, Phil and I put that slide in the presentation. Four months ago, five months ago, because it was driving me absolutely crazy that every time I turned on CNBC or Bloomberg TV or listen to the news, everybody was talking about how higher interest rates are going to choke off equity market returns. So again, the facts are, since 1990, we've had seven rising rate environments. 100% of observations, the S&P 500 has been positive with this cycle average return of 17% If you also look at that slide, we stack ranked best performing sector to worst performing sector. And you can see and it's interesting, I just heard it this morning how technology companies are going to take it on the chin when interest rates rise, yet going back over the last 30 years, guess what the best performing sector was in a rising interest rate environment, technology. 34.4% average cycle return over the last seven years, over the last seven rising rate cycles.

Now look, mathematically, do higher interest rates cause a lower equity risk premium? Mathematically, absolutely. But again, in an environment where two of your four sandboxes that you could dig in for investments, cash and global fixed income are getting you a negative real rate of return. Until that situation changes, you're going to continue to see flows into equities and private investments as the only bastion for positive real returns for investors. That can't last forever, and we know that we're going to highlight when we think that timing is going to change and our December 15th presentation. But for now, we don't believe, at least in the short term, for 2022 and 2023 that rising rates and especially real rates will have a material impact on stock market returns at least over the next two years.

Amy: Thank you, Brent. Phil, let's give Brent a second to catch his breath and move over to the real estate market. You covered this quite a bit during the presentation, but we have questions around whether we believe the real estate market is frothy.

Phil: Good question, and I'll dig into that just a moment only thing to add on that rates question, slide 15, Amy the speech is in the end, it's why are rates rising? So if rates are rising because growth expectations are increasing, then that is really good for markets. And that's what we've seen in the last seven cycles. This year, rates have risen. The 10 year has risen dramatically. If you look from last August at the bottom to now and stocks have risen very sharply, so interesting that rising rates for some reason are viewed as negative. Rising rates indicate that future growth is higher. If you have something like an inflation scare, the 1970s then that's a different ball game. But obviously, the stock market is not looking at the current environment that way.

In terms of the real estate market being frothy like you can't ignore, it's a great question. Home prices have recently been rising 20% year over year. You compare that to the long-term average long-term average for real estate, residential real estate is mid-single digits, so really dramatic returns. Clearly, this sort of appreciation is not sustainable in the long term, but tight supply, low mortgage rates and a demand for homes driven in part by lifestyle changes during the pandemic drove home values higher. Right people move to regions that they felt attractive during the pandemic, and we've seen that, of course, locally as well. For now, home sales remain robust and the market remains extremely tight on the supply side. But what headwinds might slow the housing market down the road?

As we showed the presentation of supply of homes is still tight, but has rebounded from lows. So just look in my neighborhood, there are homes popping up everywhere. Clearly, there are some supply coming online, regionally and nationally. Secondly, mortgage rates are low historically, you can't ignore that, but above the lows earlier in the year and could certainly rise in coming quarters and years, so that impacts affordability. And eventually, as always happens in real estate, insatiable demand will ebb. And home price appreciation will come back to Earth as supply and demand come into line. Does that mean it's happening tomorrow? These things can go longer, as Brent mentioned in the presentation, than you might think, but certainly the fundamentals would appear that way. Now all this said, housing is a regional phenomenon. It's dangerous to just look at it as a national thing like you would the S&P 500. Local dynamics play a key role. Areas with population job growth will inevitably fare better as they usually do, but not all regions are going to be created equally. Not all towns will be, either.

Amy: Thanks, Phil. Brent, let's do one more if that's OK. We've talked about stocks and real estate at length today, and I've got a question in here that just simply says stocks or real estate. Would you like to say a few words about that?

Brent: Yeah, I am going to disappoint the person who asked that question. I'm going to say both. Uh-huh but let me be very, let me be very clear. If we're talking about private real estate through a diversified fund or an approach that invests in, you know, single family homes, apartment complexes, multifamily, commercial, real different story, you know, I would say the forward market for both private equity, private real estate special situations. Private credit probably looks a little bit better over the coming decade than stocks, but not by a lot. I think when we end 2030, we're likely to see the difference between private investments and stocks being a little bit closer than looking at all the entire series. But an average private investments has been averaging anywhere between 3% to 5% better per year than public equities. Again, to Phil's point, it really depends what you're looking at in a diversified fund approach. I would say maybe private real estate might have a little bit on top of stocks for the next decade. If we're talking about potentially just your own individual home or speculating in real estate yourself or building something. Obviously, it's very market specific and regionally specific. So again, I'm going to disappoint. I'm going to say you need to have both in your portfolio and a very thoughtful, risk optimized fashion always.

Amy: Yes. Absolutely. Brent, Phil, thank you both for sharing your thoughts and answering questions for us. We'll go ahead and wrap things up. I want to thank you all for being on the webinar today. If your question wasn't answered, please reach out to your First Citizens Partner. Our final Making Sense webinar for 2021 is scheduled for Wednesday, December 15 as Brent mentioned a couple of times, and we'll be sharing details about that in the next few weeks. You can find information on all of our webinars at, along with some other resources we think you'll find helpful. In the spirit of the holiday, I want to share our gratitude for your trust in us to bring you quality financial information. From all of us at First Citizens, thank you so much for everything you do, and we wish you and your family a happy and safe Thanksgiving holiday.

Brent: Thanks, everyone.

Amy: We'll see you in December.

Phil: Thank you.

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