Market Outlook · February 24, 2023

Making Sense: February Webinar

Brent Ciliano

CFA | SVP, Chief Investment Officer

Phillip Neuhart

SVP, Director of Market and Economic Research

Making Sense: February highlights webinar replay

Amy: Hello, everyone and welcome to the First Citizens Wealth Management webinar series, Making Sense, where Chief Investment Officer Brent Ciliano and Director of Market and Economic Research Phil Neuhart help you make sense of what's going on in both the markets and the economy. I'm Amy Thomas, a strategist here at First Citizens Bank. And before we get started, we do have a couple of housekeeping items to get through. First, this webinar is being recorded, and a replay will automatically be sent to you following today's conference. Secondly, this webinar is interactive. If you'd like to ask a question, please use the Q&A or the chat feature on the righthand side of your screen. All questions are confidential and only visible to myself and the panelists. I do want to remind you, we try to keep our discussion broad so if we're not able to answer your question on today's webinar, please reach out to your First Citizens partner. Just as a reminder, the information you're about to hear are the views and opinions of First Citizens Bank and should be considered for educational purposes only. With that, Brent, Phil, we're ready to go, so I'll turn it over to you.

Brent: Great, Amy. Thank you so much. And good afternoon, everyone. Well, Phil, January was a great start to the year for stocks and bonds. February, not so much.

Phil: Not so much.

Brent: So, Phil and I are going to focus today on some of the key drivers of that volatility, namely better economic data here and abroad. You know, high and stubbornly persistent inflation and the market's reaction function to both of those things has driven a lot of fixed income and equity market volatility. Then we're going to shift gears and give you a market update. Phil, last time we talked about and gave a synopsis on '22. This time around, we're gonna talk about corporate earnings and profitability. We're gonna answer the two questions that clients care most about, which is, hey, the market started to get a little bit rough. What might the floor under equity markets be? And by the way, the market sold off since January 3rd of 2022. When will I get the value back in my equity account? We'll talk about our 2023, basically 12-month-forward price target for the S&P 500. And then we'll talk a little fixed income as well. So, Amy, why don't we jump right in?

So, Phil and I, you and I covered this before in our 2023 outlook. Global growth is certainly decelerating, and focus on the gray line, folks. Run your eyes across and you can see global real GDP is decelerating. If you look at that far righthand column and you look at consensus, expectations are looking at 2.1% for this year. And Phil, let's put that into perspective. Is that a good number? Is that a bad number? So if I go back post-1981, the long-term real global GDP growth number has been about 2.9%. So if 2023's expectations come through to fruition, you're looking at a growth deceleration, geez, of about 28%, so a material slowdown. And as you run your eyes down that column, all eyes are focused on US growth at 0.6%. Long-term post-1972 has been about 2.7%. The last 25 years, 2.33%. So material expectations for slowdown in the United States.

Phil: And the one outlier you see in this table is China, right, accelerating to 5.1% from 3%. So an acceleration. That's because they're reopening.

Brent: That's right.

Phil: So really, China is the exception in the global picture. More broadly, we're seeing slowdown.

Brent: Absolutely. So let's triangulate, Amy, and let's go to the next slide and let's look at US growth, which is top of mind for everyone. On the lefthand side, you can see that 2022 bar consensus expectations are thinking 2.1%. On the right, expectations for this year at 0.6%. A couple weeks ago, Phil, that number was about 0.4%. So as better economic data has come in, that number's come up materially. I think looking at the righthand chart, when you look at the quarter-over-quarter growth, market participants believe that much of the slowdown is likely going to be in that second or third quarter of this year. The one interesting note is when you look at that first-quarter bar of 0.1% for this quarter, when we go back to this last Friday, the Atlanta Fed GDPNow forecast is looking at the potential for 2.5%, which would be the highest bar on this entire page. So a lot of volatility in the economic data, and we're going to be very data dependent from here.

Phil: That's right, and an example was a recent retail sales report, much stronger than expected, start to push up estimates. So we're going to see volatility around this data. But the theme of slowing is probably going to be persistent throughout the year.

Brent: For sure.

Phil: Let's talk about what is on everyone's mind, and that's inflation. We're tired of talking about it and you're tired of hearing about it. But it's what's driving markets, it's what's driving monetary policy. So here we're looking at the consumer price index year on year. Headline inflation is the gold line. It peaked last summer at 9.1% in June. We've marched pretty steadily lower, most recently at 6.4%. But you'll notice that the sort of down, downtick is slowing. The rate of decline is slowing. It's sort of a sideways move now. That was in the most recent report, and it's something the market's paying attention to and certainly something we need to as well. But broadly, inflation's coming down, right? That's one of the reasons the markets rallied since last October, but still high versus any historical context. So where might we be going as we flip ahead?

So consensus estimates, we show this chart often—and we'll probably continue to show until inflation is no longer such a primary story—but this is quarterly inflation. The gold bars are consensus estimate looking forward. The gray bars are what realized inflation is. So if you believe consensus which, which, by the way, if you look at the black diamonds, that was March of last year, consensus got it wrong last year.

Brent: They got it fully wrong.

Phil: But if this year they're closer to corrects, which we shall see, inflation should march lower. I have a suspicion that it's going to march lower, but maybe not the pace in the back half of the year that consensus is saying, you know, fourth quarter at 2.9%.

Brent: Yep.

Phil: That seems pretty Goldilocks to me. I'm not so sure about that. But the downdraft does make a lot of sense.

Brent: Absolutely. I mean, you just look at the velocity down from 7.1% to 5.6% to 3.8%, so much of that is compacted into the first half of this year and then just starts to slowly moderate further as you go out through time.

Phil: Right, anyone who's been on a diet knows there's that last 15 pounds that's the most difficult.

Brent: Why are you looking at me? I'm really working hard. So, anyway.

Phil: Let's flip ahead, Amy. So the, what could drivers of inflation be? So there's a few things we're not showing here that I should mention. One, supply chains, right? We've seen year-on-year improvement there. Money supply's declining. Why is that? Fiscal monetary policy tightening. But there are some other more in-the-weed reasons, that we want to study here. So here we're showing CPI owner's equivalent rent. Now that is a pretty controversial measure, but it's the government's best attempt at measuring the cost of housing.

Brent: That's right, very lagging.

Phil: It's very lagged. What it is doing is it's still rising as you can see in the gold line. But if you plot it with something like the Zillow rent index, which is an observed measure from Zillow with a 9-month lead, so, so you're seeing a lead and lag between these two lines, it tends to follow. They tend to follow each other. That has yet to happen. So, but there's reasons to think whether you look at Zillow or Case-Shiller home price index, that owner's equivalent rent could top that in coming months. So you say, well, why are we so focused on this? This one measure is 25% of CPI.

Brent: Yeah.

Phil: One measure. So it is a massive component. And if we're seeing slowdown in real estate everywhere except owner's equivalent rent—

Brent: That's right.

Phil: It would stand to reason we're going to see it there and that could push inflation down.

Brent: Absolutely.

Phil: So what does this all mean for the Fed and Fed policy? So Fed funds target rate, we're showing the upper bound of the target rate at the end of prior tightening cycles. So all the way back to 1974 on the left and each cycle since. What you'll notice in each of these cycles the Fed funds rate—that gold bar is above the rate of inflation, CPI, the gray bar here. So in other words, the Fed hikes to a point that they have the Fed funds rate, the overnight rate above the rate of inflation. On the right side, you can see today that's not the case. The Fed funds rate, the top end of the range is 4.75%. CPI is 6.4%. When might these two cross? Potentially it's in the first half of this year. And that'll be, of course, good news for investors.

Brent: And that's holding the 475 constant expectations, and we'll see in a moment, for further rate hikes, look in the cards. So it'll be interesting to see when that, in fact, does cross over.

Phil: That's right. So speaking of expectations, on the next slide, here we're showing the Fed funds rate implied by futures markets. So all this is, is investors making bets essentially on where the Fed funds rate is going to go in the future. So the x-axis, which is the horizontal axis here, is future meetings. So what you see is at the end of last year, the gold bars here, the market did not believe what the Fed was saying.

Brent: That's right.

Phil: The Fed was saying, we're going to push the Fed funds rate to 5.1% at the end of 2023. The market did not, none of those gold bars are even above 5%.

Brent: That's right.

Phil: They were saying, we don't believe you.

Brent: That's right.

Phil: What has happened following the February 1st meeting through some interviews, Fed statements, et cetera, is that the market's now starting to believe.

Brent: Yes.

Phil: And what's happened is now a 25-basis point hike is priced in for March, April, May and potentially in July as well. And you can see there's not much cuts priced in as there was later in the year in the gold bars.

Brent: Exactly, and then you put that together with the stronger retail sales data, right, the better broad economic data on PMI composites, both here and abroad. It was, it was quite clear, at least to market participants, that maybe they were getting a little over their skis and ahead of themselves as it relates to the Fed getting back to a more normalized policy. And we've seen a significant driver of yields going up in market volatility in both stocks and bonds as a result of that data.

Phil: Yeah, I mean, this both stock and bond market are very driven by Fed policy.

Brent: Absolutely, absolutely. So let's talk about something that we've been talking about almost every month, which is the incredible resiliency of the US labor market. In Januar,y we saw an incredible 517,000 jobs created, Phil. The consensus expectation was for 189,000 jobs, massively exceeded expectations. In addition, we had revised up December's numbers from 233,000 to 260,000. 350,000 jobs 6 month moving average. The unemployment rate ticked down from 3.5% to 3.4%. And folks, long-term unemployment post the '70s was about 5.8%. So we are materially below long-term unemployment levels. So the labor market is incredibly strong. And the labor market overall is ridiculously tight. One measure that, on the next slide, Amy, we've been talking about, you know, job openings-to-unemployed ratio, and you can see an enormous spike up Phil, where the number of open jobs we talked what, 11 million open jobs in the JOLTS report? And you saw that hit a high and then it started to work itself down. But then recently, look at that big leg back up. We have 1.92 open positions per unemployed person. So again, the labor market remains incredibly tight and is likely to be that way for some time, despite a lot of the stuff that gets into the financial news media on technology companies who probably got a little bit over themselves as it relates to longer term.

Phil: And I think if there's something, that if you polled us, economists, investors, 12 months ago, and you said the Fed is going to raise rates as aggressively as they have, I don't think many would have said the labor market would have hung in to the extent it has. It really is a profound surprise for market participants.

Brent: Absolutely, and one of the more important components of the labor market, Phil, is what people take home. So we look at the next slide here and look at US average hourly earnings and wage growth, right, we're coming down from 5.9%, which was the high moderating lower at about 4.4%. But that's still incredibly robust growth, Phil. We're still more than 50% above the long-term average of 2.9%. And while that's absolutely good for consumers and good for the economy—again, you know, 69% of US real GDP is consumption. So as goes the consumer, as goes our economy—maybe not so good for corporate earnings and profitability and corporate margins.

Phil: Yeah and speaking of margins, if we flip ahead a couple slides, Amy, higher wages, higher cost of goods sold are impacting company margins. So on the right side, we're showing it's estimated forward S&P 500 profit margin. And what you see is, one, an unbelievable rise to multi-decade high in margin, fiscal stimulus, monetary stimulus. That money finds its way into the financial system and into corporate profits. What we're seeing is a deterioration of that. Right, and really, we're kind of moving below the previous trend now. Now the market priced this last year, to some extent. The market sold off, as earnings grew, the market sold off 24.5% for a reason. It was looking forward to this happening, but it is starting to play out.

So speaking of earnings on the left side, fourth quarter, if we flip back, one, Amy, fourth quarter earnings coming at -4.7%. So that is a decline in earnings expected full year for last year, 4.1% earnings growth, that is—

Brent: Decent. Decent.

Phil: Below long-term average and 2023, 2.3%. That number has fallen precipitously as people have realized that earnings estimates were just too high. The long-term average is 7.6%. So again, we spoke about slower growth in terms of GDP. It's going to be slower growth in terms of corporate earnings. Again, the market knew a lot of this was coming. That's why it traded the way it did last year. But it is coming to fruition.

So one more slide on earnings, from a quarterly basis you see fourth quarter and first quarter negative earnings growth, then a positive rebound in the back half. The truth is, as we get first quarter earnings in a few months, those numbers are going to be sharpened in the back half of the year, but certainly slower growth. It also is different than when GDP showed.

Brent: Yeah, exactly. That second chart that we showed where we saw that GDP might contract in the second and third quarters. Obviously, the economy works on a lag, corporate earnings and profitability. It is more, and more real time and actually in advance of what normally goes on.

Phil: So how does that earnings feed into valuation, Brent?

Brent: Yeah, so the question that you and I have been getting a lot this week and actually a little bit of last week is the equity markets started to sell off. Are we going to retest the October 12th of last year lows? Where might the floor be if we continue to sell off? So we showed this, I think it was in our 2023 outlook and we're looking at valuation-implied floors for the S&P 500, and we're looking at the next 12 months PE ratio. So Phil, what does that mean in English? It basically means, what are investors willing to pay for a dollar of earnings over the next 12 months? Right, that multiple times the earnings per share that you nicely covered at $224 a share, those two things together get you the S&P level. So over the last decade, you can see where those valuation floors have been. Back on October 12th of last year, we bottomed out at 15.5 times 12-month forward earnings. Over the last decade, the average of all those numbers, Phil, has been about 14.7% The worse we got to was 14 times. So when you look across that and you say, okay, we'll mathematically work this out, if we were to get back to the October 12th valuation floor of 15.5 times, times $224 a share, that would put the S&P 500 floor at around 3,500. If we were to actually trade, let's say, at the average of all those low points, 14.7 times, that gets you to a level of about 3,300. If, God forbid, we were to trade down to 14 times like we saw back in the late 2018 or early 2019 of 14 times, that gets you to 3,100, which is not that far off of our 12-month price target that you covered for our bear case, for sure—

Phil: A bear case, that's right.

Brent: So other things that we wanted to focus as it relates to next 12-month potential returns for the S&P 500. Again, we covered this in our outlook. And what we're looking at here is the University of Michigan Consumer Sentiment. And I want everybody to focus their eyes below the dotted line. All of those are lows in consumer sentiment. Back in June of last year, we hit a low of 50.0, which is the lowest reading in consumer sentiment since this data series started back in the early '70s. What you see next to any of the black dots and the dates on the bottom is the 12-month forward return for the S&P 500. And what you can see is that 100% of observations, Phil, since we've been recording this data, the S&P 500 has been positive 12 months post those sentiment lows, the average has been 25%. The lowest that we ever saw was back in October of 2005 at 14.2%. So where are we post the June 30, 2022, lows? Well, the S&P 500 is up about 9%. So again, history doesn't always repeat itself, but let's hope it continues to rise.

Phil: Something that's interesting in this chart—and why they're giving Nobels to behavioral economists these days—is look at the return after 12-month highs.

Brent: That's right.

Phil: In sentiment, plus 4.1%. So post lows plus 25%, post highs plus 4%. So when everyone's feeling really good, the market and it feels obvious that stocks are just going to go up, the market does worse than when everyone's feeling bad and it's obvious stocks are going to go down. It is a reminder that if we let emotion drive our investment decisions and what's happened, say, the last few months is a recipe for disaster.

Brent: And that's why market timing rarely ever works because of all those things that you highlighted.

Phil: Absolutely.

Brent: So another slide to talk about where we might be headed from a market perspective looks at when the S&P 500 back in the '70s, what it did post peak inflation. That's the gray line here. And you can see that vertical line that's basically back where that November 1974 peak in inflation. And as you kind of, you know, go to the left there, you can see that gray bar post peak inflation, the S&P 500 did trend up. But I think what's clear in this line, Phil, is that it was not a straight shot up. There was a lot of chop, a lot of volatility, and the gold bar is where we are, so the gold line is where we are today. And you can see post highlighted, which was, you know, June of last year, peak of 9.1% and CPI, similar trend to what we saw in the '70s. So I'll knock on wood and hopefully follow the similar trend that we saw in the '70s.

Phil: Let's hope so. And another potential positive as we look forward on the next slide is, what about when the Fed stops hiking? We aren't sure when that's gonna be, but let's say it's this summer, sometime middle of the year, potentially. The market tends to perform pretty well following that last Fed hike—this vertical dotted line. There's a lot of drivers. Things can change, but generally the certainty of that last Fed hike does help to drive the market higher.

Brent: Absolutely.

Phil: On the next slide, we spent some time on our last meeting talking about fiscal stimulus. We'll talk a little bit about monetary today. So if you combine the balance sheets of the Fed, of the Bank of Japan, of the European Central bank, that is the yellow line—the gold line. The S&P 500 as tended to track that, right? Now, if you—

Brent: Not perfect, but—

Phil: Yeah, and these are two trending up lines, so don't get too caught up in it. But if you do some heavier duty statistical work, you do find that even though the Fed was buying mortgage-backed securities and treasuries, there was a correlation with those purchases, the growth of that balance sheet and the S&P 500. In other words, that money entering the system found its way into stocks and pushed up valuations. So that is a headwind. We think it's the future. Not only is fiscal stimulus rolling back, so is monetary. Something to think about as we are in this transition period, in this economy.

Brent: Absolutely.

Phil: Another potential headwind, or at least driver of volatility this year is potentially the debt ceiling. We've talked about—

Brent: A lot of questions on this.

Phil: Absolutely. We've talked about this for months now. It's definitely something that's coming up regularly when we are out meeting with clients. So we wanted to show the 2011 experience. We're showing November 2010 through October 2011. There's a lot going on during that period. Quantitative easing, QE two as it was called, ended, et cetera, but you can see when the debt ceiling talks broke down. There was an S&P downgraded, downgraded our debt. There was a pretty material sell off in the S&P. So it could be a driver of volatility. We don't know how it turns out, but certainly the market does not like uncertainty. And when you think about something like Washington, that's not very controllable by investors or corporate America. It is a danger.

Brent: Absolutely, and given everything that we just talked about, where the path of the S&P 500 or equity markets broadly might go, I think this next slide is one of those slides that you rip out of the presentation, Phil, and you post up in your wall to remind yourself of what not to do when markets get choppy and volatile. And Phil, you and I have showed this slide a handful of times in previous conversations. The question that we are getting is, you know, I hit a high watermark on January 3rd of 2022. When might the equity value in my account get back to where it was back then? So what we're looking at here is every single greater than 10% drawdown post-World War II. And what I want everybody to focus on is the far righthand column, which is basically peak to trough to getting back to peak value. It's not peak S&P level, it's the total return dividends invested, which is more congruent to what the average full recovery—

Phil: Full recovery.

Brent: Full recover, full recovery in months of that dollar value. So when you go all the way down to the bottom and you look at the gray box, you can see on average the full round trip from peak to trough to getting that value back has averaged 17.4 months post-World War II because there's been some bigger ones in there, I think—the Great Financial Crisis, the Tech Bubble, which distorted things again, they were secular bear markets, not really what we're focusing on right now. When you look at the median observation, that's a much shorter period of time of almost exactly 12 months. And so just to understand this, let's look at say like a third line down and look at that 2015 to 2016 experience. So the market started selling off May 20th of 2015, took 9 months to hit the bottom, and then as you go to the far right and you look at the 11 months from peak to full recovery, it took 2 months to basically get all that value back. So 11 months was the full peak to trough to getting that value back. So again, as you scan your eyes down that right column, the broader takeaways is that 52% of the time, Phil, you got that value back inside of a year, 81% of the time you got that value back inside of 2 years and 90% of the time you got that value back inside of 3 years. So while history doesn't always repeat itself—and we're certainly, what, 14 months into this, so we're not going to hit the median, we're likely going to hopefully be closer to the average—by and large, it hasn't taken months and months and months and months and months to get that value back. But again, time will certainly tell.

So let's transition. Let's talk a little bit about fixed income. And we look at the chart on the left and we look at Treasury yields. We've been talking about, you know, with this incredible change in monetary policy and Fed funds going up as precipitously as it has. Obviously, the gray line there, which is 2-year yields, the gold line, which is 10-year yields, have gone up significantly since the end of 2021. What I want you to really focus on is that little bit of a kind of hockey stick up for both the gold line and the gray line, which is sort of post that February 1st meeting, that week or so after the Powell presser in the Fed meeting, we've seen yields widen out significantly for Treasury yields and a lot of fixed-income volatility. And then when you look at the chart on the left and we look at the 2s/10s spread, or in essence, the yield differential between 2-year bonds and 10-year bonds, you can see 2-year bonds are yielding about 0.77%, more than 10-year bonds, which is the largest inversion that we've seen, Phil, since March of 1981, which has usually been a harbinger of recessionary environments to come. Again, we're sitting at about a 60% probability for a recession again, but time will certainly tell.

Phil: That's right. So that most recent tick up on the left side, that, that's what we were talking about. That is the market coming to terms with, maybe you should believe what the Fed has been saying in terms of monetary policy.

Brent: Absolutely, and we’ve talked about on this next slide, Amy, that the fixed-income market, Phil, has been volatile. Last year, the US aggregate bond index sold off 13%, which was one of the largest, it was the largest drawdown in a calendar year in its entire history going back to 1976. Municipal bonds sold off 8.5% in one of its largest drawdowns ever. The one silver lining to the volatility that we saw last year is look at the differential in yields between the end of 2021 and where we are today. Fixed income across the entire board as you scan your eyes down that right column, yields are attractive now, and when I think of the yield to worse that we're looking at here with its US aggregate bonds at 4.8%, treasury bonds, 10-year Treasury bonds at 4%, the 10-year break even rate—which is basically a proxy for 10-year inflation—is sitting at 2.4%, much lower than where we are today. Let's hope we get there fast. But now offering a real yield and then as you scan your eyes down, look at municipal bonds at 3.6%. That's a tax-equivalent yield north of 5%. So on a forward-looking basis, forward expected returns for fixed income tend to be a manifestation of spot yield to worse. So as bad as it was last year, fixed income is quite attractive for the future.

Phil: Right, so let's flip ahead to equities for one moment just to review our next 12-month S&P 500 price target, unchanged at 4,100. That's up low single digits from where we were trading intraday today. Although that changes literally by the moment. But remember the S&Ps up something like 4% year to date, so we had single-digit gain in the S&P 500 and our expectation, but the market came out up sort of higher this year, quite a bit higher. And now we're seeing some moderation. There is more downside to our bear case at 3,100, than upside to our bull case at 4,500. Why is that? We think the market is going to bounce around. Something we've talked a lot about is that we do not think the market moves in a straight line to our base case. So we sort of shot out of a cannon to start the year, and now we're seeing some volatility again. That is not too surprising from our perspective. So we can dig into any details, of course, in the Q&A. But I do see Q&A racking up Amy and—

Brent: I can see all the questions coming up.

Phil: Let's pass that to you for some questions.

Amy: Yeah, thanks, Brent. Thanks, Phil. We do have a number of questions. We also received a number of questions in the registration process. We will get to as many as we can. If we aren't able to answer your question, please reach out to your First Citizens partner. As a reminder, you can submit a question in the Q&A or on the chat feature and get those questions submitted. Brent, this question I believe is for you. This person just transferred $75,000 from a 401(k) to an IRA account. They're about 59 years old, nearing that retirement age. How would you invest that money? And what do you think of where they should be moving forward?

Brent: That's a great question, Amy. And first of all, congratulations on two fronts. Number one, having money saved for retirement, but also getting closer to retirement age. With all my kids' college bills, I think my retirement age for my plan was 80 plus, so I'm a far ways away. I think the most important thing for anybody at this point in time as it relates to all this market volatility and what's going on—especially as one gets closer to retirement and I've said it over and over, Phil—is now is the time to have a comprehensive financial plan, to be able to sort out all those goals and objectives. And in the context of that comprehensive financial plan, Amy, part of that process is setting the strategic allocation for your dollars to make sure that your asset allocation is congruent to the duration of those goals and objectives. And that's something that you just don't set once. We're constantly updating that thoughtful asset allocation as plans change, as your goals and objectives change. And again, as we're building portfolios, we're constantly using forward-looking capital market assumptions to adjust those portfolios every quarter for that 3-year forward look ahead. So I would say the first thing that one should do is make sure that you have a comprehensive plan. And if you have a 60/40 portfolio and you've done a comprehensive plan, well then you're probably there for a reason. I would caution people to react to market volatility when the portfolio that you have is congruent to that long-term plan. Then you're just reacting, and as you said nicely, Phil, market timing—timing when to get out, when to get back in or what to own, when—is a hard endeavor. I mean, we work, you know, every single day to make sure that we have the right allocations for clients. But for most folks have that plan, first—make sure that you have that allocation that's congruent to the plan. One thing you put up. Thank you, Amy, for thinking ahead. One thing I will have in the context of that plan, if you are nearing retirement, you want to make sure that you have some emergency cash and emergency funds. We talked about how long the round trip tends to be. You don't necessarily need to have that amount of months of coverage in cash, but any amount can help if, God forbid, you have to pull from your investment account during a down market, which will exacerbate the time to recovery. Having some cash on the sidelines to help buffer that and pulling from there when the markets are down can absolutely help. But, Amy, I would say first and foremost, work with a financial advisor that can help with the allocation, work with a planner to have a comprehensive plan. If you do those two things, you'll help put aside the noise of the day.

Amy: Thanks, Brent. Phil, I know you mentioned that we're all a little tired of hearing about inflation and the Fed, but we're always getting questions about it. If the Fed decides to incrementally decrease interest rates toward the latter part of this year to avoid a recession, how should we position portfolios and what opportunities are you seeing?

Phil: Yes, so it's a great question. I think that the core is go back to what Brent just said, which is we would not recommend materially shifting a portfolio based on expectations the Fed might or might not cut.

Brent: That's been changing every single day for the last 7 weeks.

Phil: That's right.

Phil: Even, even the last few weeks, we've seen a pretty material shift there. But the real key is, have an allocation that makes sense for the longer term. Look through the shorter term. Think about the long term. Think about your goals. The vast, vast, vast majority of our clients have a long horizon in terms of their risk assets, so think about that instead of worrying about what the Fed might do, say, in the back half of the year. And just as an example of that, why it's so hard to predict and nearly impossible to time markets, is the Fed could be cutting for various reasons.

Brent: That's right.

Phil: They could be cutting because, you know, unlikely, but there's a Goldilocks scenario and the Fed is cutting because inflation's come in and they feel like they can, or they can be cutting because the economy's really falling apart.

Brent: That's right.

Phil: Either one of those cases, the market could move differently than you actually expect. Sometimes the market looks through those sorts of things. So we would say, do not focus on that sort of, do not be too much in the trees. Remember the forest, remember the long term.

Brent: And one of the things that might be helpful is to go back to our 2023 outlook where we talked about our views specifically. Now we do believe over the next decade, right, that the spread between stocks and bonds is going to have a lot more balance than it did over the last decade that ended where US stocks did 16.3% per year for an entire decade, which was materially above the 10.8% average and bonds only did 2.9%. So where you were on the efficient frontier mattered an awful lot over the next decade, with the aggregate bond at about 4.6, 4.7% was on that slide versus that longer-term expectation of stocks, there's likely going to be balance. What that is, I don't know. But it's certainly, in our opinion, going to be less than 16.3% per year that we saw, and we know the reasons why the markets did what they did in those environment where you had monetary policy and fiscal policy, easing zero interest rates for upwards of 8 plus years, is an unlikely occurrence over the next decade. So again, much more balance between stocks and bonds, which can benefit a lot of investors. So a 60/40 portfolio or whatever is right for you based on your planning objectives is certainly not dead, regardless of what the financial news media says.

Amy: Brent, Phil, you may both want to weigh in on this one. It's a pretty profound question. When will the market return to a normal state?

Brent: I guess that depends on how you're defining normal state. If the definition of normal to you is what's transpired over the last 13 or 14 years—which is massive and unprecedented amounts of monetary and fiscal policy stimulus, zero interest rates that drove risk assets in one direction, which is up. And we had these very, very quick v-recoveries, then the answer to that question is, not for a long time will we go back to something like that. We believe that going forward, we're in a regime change and we're likely to have more of u-type recoveries than v-type recoveries—a lot more balance in portfolios, and a lot more volatility. So I would say unlikely to go back to where we were over the last decade plus, which means that you need to plan more. You need to have people that build your portfolios looking forward, not backward. Sitting in a static portfolio and flipping a nickel at the S&P 500 and expecting to have great returns is likely a thing of the past. So I would argue it really depends on that perspective, Amy.

Phil: Yeah, I would only add that we're pretty clearly in a time of transition, right? We had a previous regime of easy money and now it's a little harder and times of transition can be volatile and painful. Does not mean markets don't do well. They can, but it also means that there's going to be fits and starts.

Amy: For sure. Thank you both for that. Brent, you talked, touched a little bit on allocation and the importance there in one of your previous answers, but this person's asking about core capital over the next 12 months in a 60/40 portfolio. That, of course, has been in the news a lot lately, the allocation setting. What are your thoughts on something like that and that situation?

Brent: Yeah, again, you know, it's hard to opine on just one single person's allocation, obviously. You know, your allocation is predicated on your own personal risk tolerance and your needed IRR, or rate of return to achieve your goals and objectives. And that could be various portfolios for different investors. But by and large, if you're in a 60/40 portfolio for a given thoughtful reason because that was a manifestation of your risk tolerance and your plan, it, it gets very dangerous and hazardous to your financial health to change that allocation because of what you believe might happen over the next coming weeks or months. You're in that portfolio probably for a reason. And that's probably not a great reason to change it. Again, remembering how that, you know, at least we build portfolios for clients every single quarter. We're dynamically optimizing your portfolio to be reflective of what's coming down the pike over the next 3 years and making sure that we're always looking ahead and changing that allocation when necessary to provide our clients the best outcomes. So if you're with us, you're already getting that type of dynamic changing in what we do for you. But I think it would be detrimental or a knee-jerk reaction to artificially change your portfolio just because you might be bumpy along the way. Because again, very few people are invested for the short term and hopefully you've been in that 60/40 portfolio for longer than just last year. If you know you're in that portfolio as of 12/31 of 2019 to now, you're not down. You're actually cumulatively up. You gave a little bit back last year, but you're still up. So I would say it's probably not a good idea to change when that conflicts with your risk tolerance or your plan just to be ahead of markets that you can't really time.

Amy: Thank you, Brent. Phil, Brent, can you give us a little bit of your high-level thoughts on where the housing market may be going over the next several months?

Phil: Yeah, it's a good question. Something we hear regularly on the road. Housing is important to all of us in terms of our personal assets. So, you know, a little bit of history. Everyone knows on the phone, mortgage rates rose. Home prices rose a lot.

Brent: Pushing back up closer to seven.

Phil: That’s right. Affordability fell. So we've seen a pretty material slowdown in the housing market. Whether you look at housing starts, sales, homebuilder sentiment—we've seen a pretty big slowdown. Just yesterday, existing home sales disappointed a little bit, came in softer than the consensus had hoped. But what is interesting is that inventory has not skyrocketed. Right, when you look at inventories, yes, they're higher than they were a year ago but still below the pre-pandemic level months' supply. Same thing. It has come up, months' supply of homes has come up, but still tight versus history. So we think that does provide some support to the housing market. It is slowing. There's no, no ignoring that fact that housing is slowing. But when you think about 2008-type scenario, there is the support of pretty limited supply compared to where we were coming into, say, 2008.

Brent: And it makes sense. If you were lucky enough to lock in a pre-pandemic rate of, you know, 3-ish percent or lower to move to something else and more than double your cost of borrowing, you know, north of, you know, 6% to 7%, wherever we are today, makes the cost of homeownership pretty expensive. So it does make sense why you have a lack of supply of housing, even in an environment where home prices are still relatively high versus history. So I think a lot of volatility at a national level, like you said, probably here to stay for a bit. But again, I think either you or I are expecting, you know, a 2008-type scenario where you have this cataclysmic falloff in home prices. More of a moderation.

Amy: Brent, I'm seeing a couple of questions around geopolitical events and we're coming in on the 1-year anniversary, which is hard to believe, of the crisis in Ukraine. Got a question around how that might impact markets with rising tensions.

Brent: Yeah, it certainly is disheartening to think that we're more than a year past the start of that war. And, you know, certainly our hearts go out to anyone that's affected through the Ukraine crisis and war that's going on there. I think it certainly goes without question that there are geopolitical tensions with the west as it relates to Russia, as it relates to relations with China, as it relates to North Korea. I think, though, Phil—and we've covered this in a handful of other WebExes—geopolitical tensions have been around for decades. It was always something, right? The impact of geopolitical tensions on equity markets—and I think we had a slide, I can't remember who had, probably earlier last year, where we think summarized almost every geopolitical event and subsequent market returns—more often than not from my memory, it was a positive outcome post those geopolitical events, not a negative outcome. So at least from a market perspective, geopolitical events don't necessarily have an overly high correlation with equity markets selling off. It is certainly something to watch for and something that gets priced into markets. But right now, I think that there's probably just more volatility around geopolitical events than something more cataclysmic to worry about for at least now.

Amy: We've got a couple more minutes. I love this question. It's two words long. Recession. When?

Phil: So.

Brent: I'll let you start it.

Phil: I'll dive in. So we've been at 60% recession over the next 12 months for a couple of quarters now. Look, I think that if, so elevated, odds-on chance of recession not a slam dunk. So if it's 60% recession, that means 40% chance no. I think that if we do, you're talking sometime middle of this year is probably when it starts. Now we will find out for well down the road because the NBER will tell us on a huge lag, so we'll all argue for the rest of this year if it were to happen or not. But there's reason to believe that the first quarter, we might be hanging in a little better than we previously thought. So it is probably, you know, a second, third quarter type thing.

Brent: Well, and let's, I'll put my opinion in here. Well, let's make this clear. A recession would be one that would be induced by Fed policy.

Phil: Right.

Brent: Not, not because the US economy is slowing down. We just covered the jobs market. There's no recession there, for sure. You got one of the best labor markets you've seen in 53 years, right? We've had the broad composite PMI data for both manufacturing and services that are in expansion territory. In the eurozone, we're seeing expansion. What that is lending itself to is that US and foreign central banks need to be more aggressive to keep inflation under control. So if we do find ourselves in a recession, we believe it's likely going to be shorter lived and less deep and less protracted because it's one, induced by monetary policy events, not necessarily because we have a natural, you know, business cycle and we have growth slowing and a labor market unraveling.

Phil: And on the line you might be saying, well, yeah, but the Fed started hiking almost a year ago. Well, Fed hikes impact the economy on a lag.

Brent: That's right.

Phil: Depending on what research you read, 6-, 12-month lag—big lags. So the Fed funds hitting really high levels, you know, sometime late last year may not be feeding into this economy for a few quarters. So we haven't felt the full brunt of that lag. We are seeing a slowdown in things like manufacturing, even as the consumers remain really strong. And we're a consumer economy. So it is not a slam dunk. But if it were to happen, there's reason to believe it's in the next couple of quarters.

Amy: Thank you, Brent. Thank you, Phil. We'll go ahead and wrap up but before we do, you may have noticed the QR code up on your screen. That code actually takes you to a subscription form, where you can sign up to receive all of our latest updates. And if you're on your phone for this webinar or you're having trouble with the QR code, you can also visit to get to that subscription and sign up.

If you're joining us for the first time today, first of all, thank you for being here today. We've been hosting these monthly webinars for about 2 years now. We also have a lot of other resources available to you, anything from weekly updates where Phil talks about the week ahead and that is delivered every Monday morning. We also have Q&A videos where Brent and Phil touch on a couple of questions they're hearing most often from client events. We also have written commentaries and a number of other things. If you'd like to receive that information right into your inbox as soon as it's available, I'd encourage you to sign up for that delivery. But Brent, Phil, thank you again for answering all the questions and for sharing your thoughts. And I just want to thank everyone for spending time with us and trusting us to bring you this information and helping you make your financial decisions. Our next market update webinar is March 28th. That's a Tuesday and we'll be sharing more information about how you can register in the coming days. But for now, thank you again for being with us. We hope you have a great rest of the week, and we hope to see you next month.


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Markets are starting to believe the Fed

Markets began 2023 with vigor but have recently seen volatility return. Why is that? We believe markets are reacting to the confluence of better US economic data as well as the release of January's consumer price index print, which showed that inflation remains high and the rate of moderation has slowed. As such, market participants now expect more rate hikes from the Federal Reserve this year than previously priced into markets. Since the Federal Reserve's meeting earlier this month, market expectations are showing signs of stronger alignment with statements from the Fed, whereas prior to this month futures didn't accept that the Fed would continue hiking rates or keep rates high for longer. We believe that shift is driving much of the volatility in both equity and fixed-income markets.

In its December meeting, the Fed projected that the federal funds rate would be above 5% by the end of 2023—meaning multiple hikes this year. As of December 31, the market expected the rate to be near 4.5% at year end. As of this week, that expectation moved above 5%.

Bottom line for markets

Our base case S&P 500 price target for the next 12 months is 4,100. We continue to believe that markets will experience a bumpy road this year. Having the right balance between stocks and bonds as part of a thoughtful and strategic financial plan will help you reach your return goals.

This information is provided for educational purposes only and should not be relied on or interpreted as accounting, financial planning, investment, legal or tax advice. First Citizens Bank (or its affiliates) neither endorses nor guarantees this information, and encourages you to consult a professional for advice applicable to your specific situation.

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Your investments in securities, annuities and insurance are not insured by the FDIC or any other federal government agency and may lose value. They are not a deposit or other obligation of, or guaranteed by any bank or bank affiliate and are subject to investment risks, including possible loss of the principal amount invested. Past performance does not guarantee future results.

First Citizens Wealth Management is a registered trademark of First Citizens BancShares, Inc. First Citizens Wealth Management products and services are offered by First-Citizens Bank & Trust Company, Member FDIC, Equal Housing Lender; First Citizens Investor Services, Inc., Member FINRA and SIPC, an SEC-registered broker-dealer and investment advisor; and First Citizens Asset Management, Inc., an SEC-registered investment advisor.

Brokerage and investment advisory services are offered through First Citizens Investor Services, Inc., Member FINRA and SIPC. First Citizens Asset Management, Inc. provides investment advisory services.

Bank deposit products are offered by First Citizens Bank, Member FDIC.

See more about First Citizens Investor Services, Inc. and our investment professionals at FINRA BrokerCheck.