Market Outlook · February 24, 2022

Making Sense: February Highlights

Brent Ciliano

CFA | SVP, Chief Investment Officer

Phillip Neuhart

SVP, Manager of Institutional Portfolio Strategy

Making Sense: February Highlights webinar replay

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. While everyone’s logging in, I want to share a couple of housekeeping items with you. First, this webinar is being recorded, and a replay will be sent to you following this conference. Secondly, this webinar is interactive. You'll have the opportunity to ask questions. If you submitted a question during the registration process, thank you. Your question is in queue. Should you have a question during the call today, please use the Q&A or chat feature to submit your question on the right-hand side of the screen. All questions are confidential and only visible to myself and the panelists. I do want to remind you that we try to keep our 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 opinions of First Citizens Bank and are for educational purposes only. If you have any concerns regarding this information, we ask that you reach out to your First Citizens Relationship Manager. And with that, Brent, we are ready to go. So, I'll turn it over to you to get us started.

Brent: Great well, thank you, Amy, and good afternoon, everyone. I hope all of you are doing well. So, for today's call, Phil and I are going to break down the discussion into three broad sections. First, we're going to give you a high-level update on US economic growth, progress in the labor market, the state of the US consumer and corporate earnings and profitability. Then second, we're going to get deeper on two topics that have been dominating client conversations of late, and they are, one, Fed policy and the path forward for interest rates. And two, inflation, inflation, inflation. It seems we can't have a single conversation without debating the path price takes from here. How high will we go and how long will it last? Finally, we're going to talk about where the market goes from here. And while we certainly want to get to our bottom-line views on equity markets for both this year, as well as the rest of this full market cycle, Phil and I want to address the equity market volatility year to date. What's driving it? How long might this volatility last and how might the next 12 to 18 months play out from here. With a significant movement up in yields we've seen over the last several weeks, we're going to cover fixed income performance and what to potentially expect from fixed income markets from here. Lastly, I want to get deeper on market volatility. What actually is normal? How long does it usually last and how fast if we historically recovered from declines like the ones we're seeing today? So, with that, Phil, why don't you start us off?

Phil: Thank you, Brent. Let's jump right in. As you can see here, economic growth was robust last year as the US economy reopened. We are now entering a new phase of slower year over year growth, albeit still at a decent pace, as you could see in the gold bars. This trend will likely carry across many economic data points this year. Decent economic data, but at a materially slower pace. The labor market remains incredibly tight in the most recent jobs report, the January unemployment rate ticked up slightly, but this was due to a surprisingly strong improvement in the labor force participation rate. This improvement is critical as we have a huge number of job openings as the chart on the right side shows and the tight labor market is driving up costs for companies in the form of wage gains. We have a strong labor market in the US, but that strength does have inflationary consequences. More on this later.

Brent: So big picture consumers have seen their personal financial conditions strengthened significantly in this economic recovery, consumer household net worth inflation adjusted is the highest in history, their debt payments as a percentage of their disposable income. So, think what they owe every month, divided by what they bring in every month, sits near the lowest level in more than 50 years, and the consumer savings rate is still a robust 6.9%. Despite all of this, consumer sentiment continues to fall and is at the lowest level since 2011. So, what are consumers concerned about? High and rampant inflation, supply chain bottlenecks and the political environment were cited as negatively impacting their sentiment. But thankfully, so far, consumer spending has not yet been affected and remains strong for both goods and services.

Shifting gears to corporate earnings, 2021 was just an incredible year for US corporations and despite COVID related setbacks in global supply chain issues and higher inflation, US companies are about to post the best year over year earnings growth since 2009 seeing earnings growth of an astounding 48% and revenue growth of 16%. And as of last Friday, the 18th, with more than 84% of the S&P 500 companies having reported Q4 2021 earnings growth, earnings growth has materially accelerated from the estimates at the beginning of this year and analyst expectations at the beginning of January were calling for earnings growth of about 21%. As of today, earnings growth is an astounding 32% growth for Q4. This would mark four consecutive quarters of earnings growth in excess of 30%. Just incredible. So, what are we expecting to see in 2022? Well, consensus expectations are for earnings growth of about 9% and revenue growth of approximately 8% And while this is certainly lower than 2021's incredible growth rate, it's more than 40% higher than the long-term growth rate for S&P 500 companies, which has been about 6%. What's most impressive to me is the expected growth in earnings per share. Earnings per share for this year is expected to be a huge $226. And folks, to put this into perspective, that's 39% higher than the highest level ever achieved pre-pandemic, which is back in 2019 of $163 per share. And when I look out over the next two years, analysts are seeing EPS of an astounding $267 per share in 2024 which is almost 64% higher than that pre-pandemic trend in record.

Phil: So, let's turn to inflation and interest rates, what's on everyone's mind, as most on this call are well aware, inflation is at multi-decade highs as both the consumer and producer level, as you can see on the left-hand side. Importantly, as the chart shows on the right, one and three year ahead, inflation expectations have moderated, although they remain very elevated versus history as you can see here. Expectations are beginning to price the idea that while inflation will remain elevated, the outright pace of inflation will likely moderate from the current levels. More on this later. A legitimate concern that we hear out there often is that sticky inflation is on the rise. So, what do we mean by sticky inflation? So, for example, elevated wage inflation shown in the chart on the left, might see a slowdown in the pace of inflation in wages in the future, but we are unlikely to see an outright reduction in pay in most industries. As business owners on the line are aware, cutting pay is rarely practical or popular. Additionally, as the chart on the right shows, the cost of the average consumer's primary residence has risen sharply, and the pace of gains is near the peak seen during the housing boom earlier in the 2000s. Much like during that era, inventory is tight. Mortgage rates have been extremely low since the start of the pandemic. This is beginning to change as rates have moved sharply higher this year. The pace of home price inflation will certainly slow eventually, but for now it is elevated. All this inflation is forcing the Fed's hand. The chart shows the probability of various Fed funds rate levels by the end of this year. Currently, Fed funds futures are pricing roughly six to seven 25 bps hikes this year.

Compare the current probability to October of last year when futures were pricing only one hike in all of 2022. Investors have seen quite a change of perspective in a matter of months. Expectations of Fed hikes are moving rapidly and seem to change with every new data point. We know the Fed is going to start hiking in March unless some calamity occurs, but the specific market pricing of Fed hikes tends to be wrong. The direction is usually correct. We will not be surprised to see the Fed forced into moderating the rate of hikes later this year based on slowing economic data or any number of other unforeseen events. While it's reasonable that investors are fixated on this year, we're more interested in where the Fed funds rate ends up this cycle. In other words, what's its terminal value this cycle? Last cycle, the Fed's funds rate peaked at 2.5%. If you believe futures today, the Fed funds rate peaks at 1.85% over the next three years, which would mean we're only going to see, you know, no more than one or two hikes after this year. We think there is a chance that the market is overestimating the number of near-term Fed hikes and underestimating the number of hikes in coming years. Or put another way, the long-term terminal value of the Fed funds rate this cycle could be higher than the market expects. As the likely number of Fed moves has risen, so have Treasury yields. As you can see on the left side, both long- and short-term rates have increased sharply, but the most dramatic moves have been in shorter term rates as the market scrambles to price Fed hikes.

The sharp increase in short term rates has flattened the yield curve and driven a severe decline in the spread between the 10 year and two-year Treasury. That's the chart on the right side here. We will speak to implications of the flatter yield curve later in the presentation. And the corporate world is taking note. 73% of S&P 500 companies that have reported fourth quarter earnings have cited inflation during their earnings call, according to FactSet Data. This is the highest level going back to at least 2010. Just a year prior, only 30% of companies mentioned inflation during their calls. At the sector level, consumer staples and materials companies were the most likely to cite inflation. This makes sense when you think of both input costs and finished good prices for these sectors. As Brent mentioned, these concerns have not yet fed into income margin compression. And as you can see here, investors are also taking notice. The top two risks, according to investors, are an overly aggressive Fed tightening cycle and higher than expected inflation. Interesting to note that a month ago, the number one concern was inflation, and that has now crept into worries over a Fed policy error. One concern leads to another in this case. In our view, inflation is going to remain significantly elevated until supply and demand find some sense of equilibrium. The pace of inflation will moderate in coming quarters, as you can see the chart. But at what speed is the concern. As you can see, just because the pace of inflation moderates does not mean we reach the all-important 2% level of inflation any time soon. Also, the pace of inflation declining does not mean prices all out fall. There are no negative numbers on this chart. In our current economy, we have an elevated demand in the form of robust consumer spending and supply constraints in the form of supply chain shortages in order backlogs. There are two types of people in this call. The businesses and the consumers both feel the brunt of inflation, for sure. To this point, much of the cost increases have been passed on to the consumer. You would think persistent inflation would eventually feed back into corporate margins.

Brent: There's an awful lot going on in both equity and fixed income markets, so let's dive right in. As Phil and I discussed back on December 15 during our 2022 market outlook, we stated that this year was going to be significantly volatile, and so far that's unfortunately proving to be the case. And by the way, if you haven't listened to that outlook, it's still available and still very much worthwhile to listen to. So, year to date, US equity markets are down about 10%. Value is outperforming growth, and large cap is outperforming mid cap and small cap in the United States. More broadly, international markets are outperforming US markets by a wide margin year to date about 6%. I want to jump in to the two questions I've been getting most from clients over the last two weeks, and they are, number one, where is the support level or floor under this market? And number two, what's the next directional move for markets from here?

So, let's tackle the first questions first and talk about the technical support level for the S&P 500. The next level of support from here is the three month intra-day low of 4,222, which we saw back on January 24. Ironically, that was the day that we had over a 5% intra-day move and the S&P 500 actually finished up at 4,400. Failure for this level to hold would certainly have broader trend implications and see the next level of support for the S&P 500 around a little bit above 4,000. So, to answer the question, what's next for markets, we might want to look at other technical indicators like the S&P 500 put-call ratio, which is nothing more than an indicator of market participants hedging out in the marketplace, as well as bull-bear sentiment indicators. Both are indicating that markets are starting to get into the historically oversold range. Why is this important? Because historically, when markets have reached these oversold levels, the forward six-month return has averaged a positive 8% to 9% so let's cross our fingers and hope that history repeats here. When I look at the chart, sorry, on your right, from a fundamental perspective, it's really interesting to note that despite the S&P 500 being down about 9.5% through last night, the earnings component of the equation is actually positive, almost 3%. So again, corporate earnings continue to be a market tailwind. As Phil and I highlighted on last month's call, this year is a midterm election year, and in midterm election years, we've seen heightened volatility over and above what we've historically seen in non-midterm election years. And from a timing standpoint, the volatility year to date is following the historical pattern we've seen during these periods very closely and that's that red circle that you see there. But what we believe is more important to focus on is the 12 months following midterm elections, the US stock market has been positive 100% of occurrences since 1950 with an average return of 15.1% so think November of 2022 through November of 2023. Markets year to date are very much reacting to the expectations surrounding the rate hiking cycle that's about to start, which Phil just nicely highlighted, which could begin as soon as next month.

Given this volatility, Phil and I thought it made sense to give you a historical perspective on how equities have behaved during this stage of the cycle. I thought I would first start off with the survey that Deutsche Bank took last week. They surveyed over 400 of the largest institutional investors and asked them what they believed was the major driver of the equity market sell off. The overwhelming majority of respondents answered fears of an overly aggressive Fed, significant rate hikes and the potential for a Fed policy error. What I also thought was interesting, especially with what's going on, is that while the Russia-Ukraine conflict is certainly not helping market sentiment, market participants are actually more concerned with economic deceleration here in the US than they are about fears that this conflict will materially hurt markets. Now, folks, make no mistake, if this conflict were to materially escalate, this survey undoubtedly will change. But please remember the data we showed you last month about the relationship between uncertainty and global uncertainty index and forward market returns. Higher levels of global uncertainty have historically led to higher forward returns for markets 3, 6- and 12-months post, not lower. So again, lots of uncertainty does not necessarily mean that you're going to see lower markets in the future. Year to date, yields have risen materially, and the yield curve has flattened significantly, and the financial news media has highlighted that we're rapidly approaching the yield curve inverting. Well, let's pause for a second. What does that actually mean in English? The more common and most commonly accepted definition is that it's when two-year yields, treasury yields, rise above the level of 10-year yields, thus inverting the natural upward slope of the Treasury Yield Curve and yield curve inversion has historically been a harbinger of recession, seeing a recession occur on average 12 to 18 months post yield curve inversion. And what we're looking at here on this chart is all cycles post 1970. And what is very interesting to note is that when the yield curve has flattened to below 50 bps like we're seeing today. Right before we got on this call, we're at about 38 bps on the 2/10 spread. The S&P 500 was positive. 100% of occurrences from the passing of that 50 bps threshold until the curve actually inverted, seeing an average period return of about 37% positive and a median cycle return of about 12% over that period. So contrary to popular belief and what the financial news media is throwing out there, the path from these levels towards yield curve inversion has historically been a positive one, not a negative one.

Phil: And this is an interesting point, Brent. The yield curve is flattened as short-term rates have moved rapidly to catch up with Fed hike expectations, the market was behind there. However, the Fed is aware of the risk of inverting the yield curve and will be forced to navigate a soft landing while attempting to not invert the curve. This might be why Fed funds futures are so volatile currently and pricing actually slightly fewer hikes this year than they were just a couple of weeks ago.

Brent: Exactly, so given the market fully expects the Fed rate hiking cycle to begin in earnest next month, what path of equity markets take in post Fed rate hikes? So, the graph that we're looking at here shows the S&P 500 returns 12 months before through 24 months after the first-rate hike and that dotted black line that you can see there is Fed lift off in that first hike. On this graph, the dark blue line is the average return for the S&P 500 looking at all rate hiking cycles post 1970. That light blue line that you see is rate hiking cycles and the return for the S&P 500 post 1990 and the orange line is the average return for the S&P 500 in rate hiking cycles pre-1990. And if I focus on the rate hiking cycles post-1990 for a minute, what you can see is in the graph is during the first three months after the first-rate hike, and we have it circled right there, the S&P 500 on average actually fell. However, from three months post all the way out to 24 months post, the S&P 500 generally delivered strong returns and actually all three cycles saw average S&P 500 returns positive 24 months post the first Fed rate hike. It's pretty incredible. Also, please remember and I know that we covered this slide the last couple of WebEx’s, remember that over the last seven rising rate cycle spanning the last 30 years, US stocks have been positive 100% of occurrences with an average cycle return of plus 17% so again, despite what gets mentioned in the financial news media, rising bond yields have not negatively impacted stock returns.

Phil: So, let's turn to the fixed income market and slide 24. As bond yields have risen rapidly this year, as you are all well aware and we discussed early in the presentation, the price of bonds has fallen. You can see that in the tables shown here. Remember when the financial News Center, their attention on the more than $14 trillion in negative yielding debt globally? Well, in less than two months, the total universe of negative yielding debt has fallen by more than 70% to now just more than $4 trillion. As is always the case when yields rise, investors feel the pain of price declines on the front end. But the longer-term result is higher yields in which to invest, and that is a good thing in the end for bond investors. It was an annual tradition at this point, the consensus expects the 10-year Treasury yield to continue to rise, but most do not have an extreme move baked into their forecast from here. The majority expect a 10-year Treasury yield range between 2 to 2.5% by the end of the year, compared to a yield just under 2% today, so not an astronomical increase from today. Much of the Fed and inflation concerns seem to be priced into the bond market, and as such, while rates are expected to rise further, additional rapid upward moves in Treasury yields like we've seen in the past three months do seem less likely.

Brent: So, with all this market and geopolitical volatility, I really wanted to take a moment and try to bring you all back to center, as it's really easy to lose sight of what is normal when it comes to volatility, as well as how long has it taken investors to recover from these bouts of market turbulence? So, what does normal volatility actually look like? What should you expect as an investor? Well, looking back at the last 40 plus years of data, market drawdowns are not only common, but they've occurred every year for the last 42 years. So let me say that again, they're not only common, they've occurred every year for the last 42 years and to drive home this point even more, the average intra-year drawdown is an uncomfortable negative 14% per year. But despite this large annual event, markets have finished the year positive 32 out of the last 42 years or 76% of the time, so please, please, please understand that as uncomfortable as it is to see markets fall like we're seeing today, these types of moves are very much a normal aspect of the yearly market movements. And I said this on last month's call, and I'm going to say it again on this month's call, of all the slides we're going to cover, this slide, to me, is the one that you rip out of this presentation deck. You have thumbtack in your office wall and you refer back to it every time the markets get a little bit rocky. So, what we're looking at here is every 5 to 10%, every 10% to 15% and every 15% to 20% drawdown over both the last 100 years (that's the gray bars that you see there), as well as post the great financial crisis, i.e., post 2008. They’re the blue bars on this chart. The bottom line here, folks, is that drawdowns of 20% or less fully resolve themselves very quickly. So, let's get to the graph. From 1928 until last year, drawdowns of 10% or less resolve themselves fully inside of six months. Drawdowns of 10% to 15% recovered fully inside of nine months and 15% to 20% drawdowns effectively recovered within 12 months. And post the great financial crisis, that recovery time is even shorter, with most drawdowns of 20% or less fully recovering inside of three months.

Folks, it's hard to remember. Remember back to February and March of 2020. In less than a month, we saw the markets fall 34% from February 19th to March 23rd. In 9 months, you got all your money back and then some. So, while it can be very nerve wracking to see the value of your investments fall. Understand that it usually does not last long and behaviorally reacting to these falls and moving away from your needed asset allocation can be incredibly detrimental to the achievement of your long-term goals and objectives. So, let's bring this home and give you our bottom-line views on markets this year, as well as full market cycle. I want to start off by first addressing Wall Street consensus because it's quite frankly, it's pretty astounding. Consensus has 12-month forward price target for the S&P 500 as of last Friday, the 18th, with all the stuff going on. Their target is 5,312. That's more than 21% up from last night's value, and it's about almost 12% return from end of last year, 2021’s close of about 4,766. So, Wall Street consensus is quite optimistic on the path forward from here for the market. Our 2022-year end S&P 500 price target is 4,900. As we said this many, many times we're seeing earnings growth moderating, not really slowing, but moderating. Operating margins are going to have to fall from the record highs. It's really the pace to which they fall and inflation pressures and supply chain issues, we believe, are going to take a bigger bite than what's expected in price into markets. Back on December 15 of last year when we put this out here, we said that very simply, simple math here, 8% to 10% EPS growth for the S&P 500 minus about a 5 to 7% multiple contraction when interest rates and inflation rise the multiple in the S&P 500 contracts. When you net that out, you get about 3% growth in the targets about 4,900. Look, we still believe that that's the case, and while we're optimistic, we're just not as optimistic as consensus for this year. And the last bullet here is what it might really be hard to contemplate now, given all the volatility today. We believe the S&P 500 can potentially achieve 5,500 or greater by about year-end 2023. And while markets and global events today are very, very noisy today, between now until the end of 2023 will some, ask yourself this question, will some of these things that are bothering us today be better or worse?

Alright, let's think about those things. Think about COVID, better or worse? We think better. Inflation, better or worse? We think better. Global supply chain issues, geopolitical tensions, both at home and abroad, we believe, will be better by the end of 2023 than they are right now. And as Phil nicely stated, despite peak concerns, margins and earnings are better, not worse. S&P 500 companies have been able to thoughtfully pass through the costs to their end client. And even if earnings don't get us all the way to $267 per share and the market multiple doesn't get to 20.5 times, which folks, remember, still is a pretty significant contraction from the 23 times that we had back in January of 2021. The market math still gets you north of 5,000. What I want to be incredibly clear on is that we are not calling for the end of the cycle on December 31 of 2023. History has certainly shown us that markets can run well beyond the fundamentals, but broadly, we are constructive and optimistic on markets through the end of 2023. So, Amy, with that, I can see the questions are really piling up. So hopefully that means this is a good one. Maybe we can open up for some Q&A.

Amy: Yes, thank you, Brent. Thank you, Phil, for all that information. We do have several questions already and we received several through the registration process so just a reminder, if you have a question, submit it in the Q&A or the chat feature on the right-hand side of the screen. Also, just want to remind you again that we do try to keep the discussion broad. So, if you have a specific question, please reach out to your First Citizens Partner. Brent, you might have anticipated this one. We've gotten multiple questions around the conflict with Russia and Ukraine, and that's the overall expected impact for the US economy and markets in the near future.

Brent: Yeah, yeah, so let's talk about it, right, so, so conflict with Russia is not unexpected and certainly has been the norm over the last 20 plus years. Let's go back to 2008 and think about the invasion of Georgia. Let's go back to 2014 and think about Russia's invasion into Crimea. So, if we extrapolate this out, this is again, nothing new. So, if we go back and think about historical observations, when we've had this type of conflict, you might say to yourself, what's the impact on both the US and global equity markets when this has occurred? In the three times that this has happened, equity market impact for US equity markets has been sub 10% drawdown and actually in the last two, when I go back and I mentioned 2008 and 2014, the drawdown in US equity markets that were related and again, you'd have to, there are other things going on at the time related to that conflict with sub 5%, right? If I were to take it back and think about where the pain might actually be. I think there's a couple. Economically, I think that this is likely to impact Europe and specifically Germany and surrounding countries more, because right now, 40% of energy comes from Russia. So, think oil through Nord Stream, ultimately through Nord Stream two and pipelines and more specifically, even Beyond Oil, you're looking at natural gas, so I think economically it's going to be a very delicate tightrope to walk in negotiations between the broader NATO nations and the EU and Vladimir Putin and Russia. As it relates to the US, less dependent, certainly on that oil so think economically, we're going to hopefully be more insulated than Europe. That still does not mean that energy prices won't react. And we do believe if the conflict escalates, we're already starting to see it that energy prices when you think about WTI, Brent, Crude Natural Gas, even base and ferrous metals, we're starting to see rise. So, we think that might be the biggest recipient of price appreciation would be on the commodity side of the equation, Amy, but by and large, not that big of an impact on equity markets unless it turns into something much broader of a conflict, which we don't think will be the case. Ultimately, most commodities and energy related stocks will be the recipient.

Amy: Thank you, Brent. Let's bring it back to the US here, it doesn't take much research to see that the housing market prices just continue to increase, as we've seen. Can you talk a little bit about that price increase and its overall impact on the stock market and the economy?

Brent: Sure well, let's bifurcate that conversation. Let's just talk about the housing market. Well, we got a Case-Shiller 20-City Home Index information this week. I mean, my gosh, folks, 20 city home index home prices year over year through January to January increased 18.6% right, so while the housing market has been very strong, both single family and multifamily, there are some things that we think that are going to collide into that that will ultimately start to maybe cool off at a national level the single and multifamily housing market. So, think higher interest rates, higher mortgage costs and ultimately the higher home prices go, affordability really becomes a problem. And the updated data when you look at that Case-Shiller 20-City Home Index is that the median home in the United States is selling for 201, sorry, I wish it was 201, 102.1% over asking which is the highest level that we've seen in more than 20 years. So, home prices are continuing to appreciate, but we believe that there will be some things that might cool off that housing market. Again, that's at a national level. Regionally, specifically here in the Carolinas, New York City, California, and the Pacific Northwest home prices, we believe, will continue to grow. Maybe not at the same breakneck pace that we've seen over the last year or two, but we believe it's going to be a very regionally specific game. As it relates to house prices and the stock market, I'm going to kind of roll that back and just think about it at a high level and think about overall balance sheet for consumers, financial assets, think the inherent price of your homes, the prices of your business, the price of your brokerage account and the value of the securities all have gone up, which you would believe would lend itself to better and higher consumer confidence, though the irony, like I covered earlier on, consumer confidence is at the lowest level since 2011. So there's a fundamental mismatch going on between the actual financial conditions of consumers and their ability to spend and how they actually believe. And thankfully, the way that they're acting is dominating how they actually think and feel, which is a good thing not only for housing markets, but for the equity markets and overall financial assets for consumers.

Amy: So, Phil, kind of in that same space in the real estate market, if we're looking more towards the retail and office space, what are your thoughts on the post-pandemic market? What's that telling us?

Phil: Yeah, and obviously those spaces have lagged residential. You know, the hot numbers Brent is citing. We've certainly not seen retail and office fall that. And as with everything real estate, as Brent mentioned, results will be regional, but there are some positive indicators for non-residential construction. So, after being crushed during the pandemic, as you would expect, non-res construction began to see year over year gains beginning last September and have remained positive since. So, we are seeing non-residential construction pick up. This modest improvement has carried across both retail and office construction. Now, non-res spending non-residential spending remains well below the pre-pandemic level, but it is still good to see gains in recent quarters and might look different than it did before the pandemic. But many jobs require a team-based approach, and we've seen a number of large corporations point to their emphasis on people being in the office to some degree. So, so there is reason to believe that the US Office is not dead, and we are seeing that in company reports as well. On the retail side, the pandemic simply accelerated trends that have been in place for two decades, right, towards online retail, for example. And really, what holds today is what held before the pandemic, right? Smart developers and companies will find the best use for retail square footage, but there are certain companies and entities that were struggling before the pandemic, and they're struggling now. And the truth has just accelerated. So retail is not going away. Brick and mortar retail, it just is going to continue to look different than it did 20,, 30 years ago.

Amy: Thanks, Phil. Let's move over to our outlook on equities in 2020 to Brent, I know you put, you and Phil put out the 2022 market outlook at the end of 2021. How are things looking at this point?

Brent: Yeah well, in the first couple of days of the year were good and then from January 4th, until now, we're down a little bit from the high watermark, which is a little bit higher than year end. We're down a little over 11%, but again, like I said. Every year for the last 42 years, we've had an intra-year drawdown, and the average of the last 42 years is negative 14%. Even when I take out those big years that had drawdowns that skew the average, the average intra-year drawdown is over 9.5%. So again, it's not been a great start, right? And the market is certainly pulling forward. Expectations for monetary and fiscal policy stimulus being taken out of the economy as we all expected and for the Fed to begin their tightening cycle as Phil nicely mentioned. Again, we do believe that when you get to the simple market math that we will see a little bit of a recovery and we still believe that we're going to hit 4,900for the S&P 500 this year. And again, we are quite constructive on this full market cycle through the end of 2023 and like I said, is it going to be exactly December 31 of 2023? Of course not. Is it going to extend into the first quarter of 2024 beyond? Potentially. Markets have a way of being very volatile, as we're seeing today. Big picture, we are constructive on the outlook, Amy, even though that we see volatility right now.

Amy: Phil, we talked a little bit, well, actually a lot about inflation on today's presentation, and I've got a lot of questions from folks about the 10 year and different spreads around. What are your thoughts on the best place to invest money in light of the current inflationary period?

Phil: Yeah, and I'll tie this into another question I see around TIPS as well and why, you know, they haven't necessarily worked, and there seems to be a disconnect there. So, you know, tackling TIPS first and then we'll tackle some of the other assets out there. You know, we saw, and so TIPS are Treasury Inflation Protected Securities, they should move with inflation, right? So, we saw large inflows by investors into TIPS related investments earlier in the pandemic. This makes sense as investors became more focused on the dangers of inflation, however; while TIPS provide some inflation hedge through their pricing mechanism, they're still sensitive to moves in rates. So, when we see big shifts in Treasury yields like we have this year and thereby real yields, right, TIPS are going to feel that, and it can subsume any benefit from the inflation hedge inherent in TIPS. This is driven recent outflows from TIPS as investors shift their focus to a Fed that is combating inflation. In terms of other assets, you know, to a certain extent, there is no perfect place to hide. If inflation is persistent, you can enter the commodity complex, Crude Oil, for example, but then you're exposing yourself to huge swings of volatility. Gold is a traditional answer as well, but it's also not superior long term asset class. If you bought gold in January of 1980, when inflation concerns were rampant, you did not break even on your investment until 2008. It's incredible. Also, commodities don't pay interest or dividends, so you better hope the price goes up. I think the easy answer is equities, to the extent companies can pass along price gains like Brent covered, inflation does not hit their bottom line. And if you own the entire market, you do have exposure to commodities through the energy and materials sector. So there's no, there's no magic bullet here if inflation is rampant, but certainly there are places to invest.

Amy: And Brent, let's switch back over to you. How are we aligning our portfolios for this year and next given the economic environment?

Brent: It's a great question, Amy. So let me just recap how we invest client portfolios. We develop forward looking capital market assumptions for a three year forward look ahead and we dynamically reoptimize our portfolios every single quarter for that three year forward look ahead. Doesn't mean that we trade every single quarter or make adjustments, but we're always looking forward and optimizing that portfolio around what we see coming down the pipe. So that's a critically important component of our process. So, when we take that three-year view, we are not looking at this today or next week or next month or next quarter, we're trying to encapsulate and look at that three-year view. So right now, if I look at our positioning, we are underweight the US large cap neutral weight basically or market weight on US large cap growth and we have been overweight, mid and small cap with a little bit of a balance towards mid value and small cap. We have been underweight, developed international, which is hurting a little bit in these first couple of weeks here. But we believe that some of the valuations that we see there, plus some of the COVID related setbacks in global supply chain issues are going to be problematic and we believe that developed international and emerging markets over the shorter term might not do as well as US markets. Beyond that, like we covered in our 2022 market outlook, like again, if you haven't listened to that, please go and listen to that because that gets into our longer-term outlook over the next decade. We do believe that we will start to see a dynamic shift where things like mid and small cap, core and value, as well as developed in emerging markets will do better looking out over the full decade in the full cycle. But over the shorter term, over the next three years, we do believe it's US over international and we do believe that it's mid and small, over large. You know, we've certainly seen an interesting change where value has been outperforming growth. We think that might continue for a little bit, but by and large, over the next three years, we do believe that will normalize as valuations start to come back into line as some of these value companies are quickly becoming fairly priced, right, so putting that value trade on there and sticking with value and saying, hey, it's going to work for the longer term, these companies are already starting to reach full value and it's starting to come back in line. So again, that three-year view or a little bit more balanced.

Amy: Thank you, Brent. And we are going to go ahead and wrap up because we are right at time. I want to thank everyone for being with us today. If your question wasn't answered, please reach out to your First Citizens Partner. Our next market update will be on Wednesday, March 30 at 12:00 Eastern Standard Time. We'll be sharing details with you on that in the coming weeks. We're also hosting a Fiduciary Update for Philanthropic and Charitable Board Members. That webinar is going to be on March 15th. Our manager of Philanthropic and Charitable Services, Hank Dunbar, will be leading that discussion, and we'll send you that registration information with today's replay. You can find information on all of our webinars at, along with some other resources that we think you'll find helpful, including that page that Brent recommends that you rip out of the deck and put up on your office wall. It's out there available for you. On behalf of all of us here at First Citizens, I want to thank you for trusting us to bring you the information that you need to make your financial decisions. Your trust in us is not something that we ever take for granted. We hope you have a great rest of the week, and we look forward to seeing you on our next webinar.

Brent: Thank you, everyone.

Amy: Thanks.

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Following the February 23 market update, Russia launched attacks on Ukraine, and markets responded upon opening on February 24. Considering this material development, we want to call out a couple of points from February's market update.

Consider history

Intra-year drawdowns are normal, and drawdowns of 20% or less tend to not last long. While volatility we're experiencing is noteworthy, keep in mind that intra-year drawdowns are the norm rather than the exception.

Inflation is at multi-decade highs, but expectations are moderating

Expectations are beginning to price the idea that while inflation will remain elevated, the outright pace of inflation will likely moderate from current levels

The bottom line for markets

Our 2022 S&P 500 price target is 4,900 equating to around +3% growth over 2021, but we expect a much more volatile year.

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