Making Sense: May Market Update

Making Sense: Monthly Market Update

Recorded on May 21, 2025

Amy: Hello, everyone. I'm Amy Thomas, a strategist here at First Citizens Bank. Today is Wednesday, May 21st, 2025. I'm joined by our market and economic research team, Phillip Neuhart and Blake Taylor. Brent Ciliano is traveling this week.

We want to welcome you to our Making Sense Market Update series. Each month, our team brings you an in-depth analysis of what's happening in markets and the economy. Before we get started, just a couple of reminders. The information you're about to hear are the views and opinions of only the authors at the time of recording and should be considered for educational purposes only. This information should not be considered as tax, legal or investment advice. If you have a question about your financial plan, please reach out to your First Citizens partner.

And Phil, with that, we're ready to go. So I'll turn it over to you.

Phil: Thank you, Amy, and thank you all for joining us this month. And Blake, thank you for participating. Look forward to our discussion today. So let's jump into what we're going to cover in this webinar. First, the economy, of course. There's tons going on the tariff front. Still a lot of updates there we're going to cover in depth. Growth from a global perspective, inflation, consumer spending and of course, what this all means for the Fed. On the market front, we were digging a little bit on US versus international, not to mention valuations and fixed income as well. So with that, let's jump into the economy, Blake.

Blake: Yeah, let's start off with the issue that's dominating market attention and headlines, which is tariffs. Since we last met a month ago, the average tariff rate that the US is charging on imports coming in has dropped from 21% to 11%. So that's a huge deal that comes on the back of the reduction in tariffs on imports coming from China from 145% down to 30%. And according to the 90-day pause that those two countries agreed to a couple of weeks ago.

However, as we can see in this chart here, at 11% we're still at the highest tariffs that the US has charged in over 80 years. So we're facing the highest tariffs that any adult in the US has seen in their lifetime. So there's still a lot to contend with here. Financial markets have cheered this news of the huge reduction in tariffs, but there's still a lot to figure out, chiefly among that is, are companies still going to import at the levels that they did last year and years prior with these higher costs involved?

Countries have spent the last 75 years, while tariffs have been declining substantially, building enormously complex supply chains. So are they going to view this increase in tariffs as a temporary factor that maybe they can pay and deal with higher costs in the short term but they're expecting for it to go away in the future perhaps. Or are they seeing this as a reversal from the great unwinding of protectionism that occurred as we can see these tariffs coming down basically to 0% over the last few decades, in which case, you know, there might be other big decisions made here.

Phil: Certainly still an uncharted territory, 80-year event that this has to matter, even if things are better than from a tariff perspective, lower, I should say, than a couple of weeks ago.

Blake: Absolutely. So we're at about 11% average tariffs. What does that comprise? There's four main buckets of tariffs that the White House has introduced this year. First is a 10% universal tariff on all imports coming into the US, with a few exceptions. Second is a 25% tariff on goods by certain sectors rather than by country. So right now, those have been introduced for autos and some auto parts and for metals like steel and aluminum that are used for inputs. And that's the second bar here in this chart.

Third, if you come over to the China bar here, then you'll see that we're imposing additional significant tariffs on all imports coming in specifically from China. Those rose to as high as 145%, as I mentioned, which is the top of this shaded bar here in the enacted portion of the chart. That was brought down a couple of weeks ago to just 30%. And that's the huge reduction in tariffs that we've seen.

Phil: Shows how important China is to this whole trade picture, certainly.

Blake: And it could come down further from 30%. Or if negotiations aren't productive, then who knows? It could rise back up. And then lastly, if you come over to the proposed portion here, then there's this 90-day suspension of the so-called reciprocal tariffs. Remember, those were introduced on April 2nd in the big announcement at the White House of this new regime of trade policy. But those were put on hold while the administration engaged in bilateral trade negotiations with countries all over the world.

What's important to note here is that since April 2nd, when all of this was introduced and the tariff rate on average rose above 20%, we've seen a reduction in tariffs since then. There have been bilateral deals between countries. There's been suspensions. There's been exemptions made. But look in the middle of this exhibit here, where we're showing that there's actually more tariffs in the pipeline. There are studies being done by the Commerce Department that we're expecting the reports to come in sometime probably this year on what's going to happen with the semiconductors and electronics sector and in the pharmaceutical sector, where it's possible, according to some analysts that we follow, we could get 25% tariffs on a huge amount of imports coming in that would raise the tariff rate even further.

So what's the point here? We have seen a huge reduction in tariffs just in the last month, but this is a very dynamic situation. I would guess that if anything, one thing we know probably with pretty good confidence is that the average tariff rate is not going to stay at 11%. It could come down further if the US and other countries decide that they want to move in a more liberal direction. Or it could go up if there's more of these tariffs introduced. So the point is, we're not locked into anything right now, even though markets have really gotten used to this direction of tariffs easing.

And we're starting to see it in real life. What is a tariff? A tariff is a tax that an importing business pays to the US government when they bring a good into the United States from a foreign country in the form of a customs duty. What we've seen from data released from the Treasury Department on how much money the Treasury is bringing in is just through March—which is the latest available that we have for the daily tariffs that are being paid into the customs and border protection agency—has shot up. This is not even accounting for the April surge in tariffs, which we're going to get that data probably in in 2 or 3 days, and I expect this line to shoot up even higher.

So what's the point? Companies are already paying billions of dollars more basically in import taxes, and that's going to have a substantial effect on spending and on prices and on bigger-term strategic decisions. What this amounts to basically is a multihundred-billion-dollar tax that's charged on the corporate sector if they decide to continue importing. So the point here is we're already starting to see these effects showing up in the data. The question is, how is it going to affect things downstream, like prices, profitability and spending.

Phil: And that's what still remains a little bit unknown. So what are we seeing from a global growth perspective and expectations? You can see what growth was across the globe in 2024, where expectations were for this year as of last December and you can see some downward revisions here, whether you look at world, US, Europe, et cetera. We have seen professional forecasters reduce numbers. Now, as you mentioned, this is dynamic, right? Are you assuming 145% remains in place all year? What do we see? But look, if global trade slows, that should slow economic growth, right? The core word, as we always like to say, of capitalism is capital. Flow of capital is pretty important to growth. We are seeing downward revisions—still positive growth, by the way—and there is a world in which some of these revisions move up as average tariff rates have come down. This remains very fluid. But nonetheless, expectations are slower in terms of growth today than at the beginning of the year.

What are we seeing in terms of some specifics on data as we flip ahead? So January first versus today, GDP expectations have come in, we mentioned. Consumer spending, same thing. Are you going to spend as much if that apparel, for example, is more expensive, or do you reduce your spending? Industrial production, same thing. Are you importing as much product to produce industrial production? Nonfarm payrolls, same thing. This is what has stayed very strong—we'll talk about in a moment—but the idea that companies are taking a wait-and-see approach. They just want to know the rules of the road. Are you implementing a major capex plan or a major hiring plan right now? And then inflation, we'll talk a lot about in a moment. But of course, inflation expectations have risen. If companies pay a duty to bring goods into the US, the assumption is some percentage of that comes out in company margin, right? Which we'll talk about in the market section. And some percentage is passed on to the consumer. This is all expectations, right? The truth is, hard data has remained pretty good. But this is where expectations are. Why do we watch expectations? Because this finds its way into markets, right? Our job is to look forward, not just backward. And expectations have slowed from an economic perspective and risen from an inflation perspective. Again, these numbers are changing pretty rapidly.

So where are we? On the inflation front, here we're showing the Consumer Price Index and Personal Consumption Expenditure Deflator. Several measures here. What you'll notice is all of them remain above the Fed's 2% target, right? We talk about the Fed being between a rock and a hard place, which is inflation's above their target even as growth expectations are falling. So do you cut, do you hike, do you hold? Right now, the Fed's on hold. We'll talk about that more in a few moments. But nonetheless, we are seeing inflation that is elevated relative to the Fed's target. Is it anywhere close to where we were a few years ago? No, right? The truth is we're much closer, much better place than we were, but still above the Fed's target.

So where might inflation go? We're very dependent on survey data right now, which for people like you and I, we'd like to see the hard data. But we're looking at surveys because that's what we have. If you take surveys from Federal Reserve regions and you look at what the question is, what are businesses reporting in terms of higher input costs, right? So various regions. And then Blake was kind enough to average these regions in that nice, thick red bar. You'll notice that businesses are reporting higher input costs. This makes sense. They should be, right? If you are paying a tariff of goods coming in, then obviously your input costs are higher.

The real question is, how does this feed into the economy? Does it feed in in the form of inflation? Do companies, do their margins fall? There's some expectation there. And then to what extent do companies, can they change supply chains? That really depends on the good. We can't make too many assumptions there, but obviously, we have a dynamic economy in the US. There are likely going to be some shifts from a supply chain perspective to try to reduce these input costs. But the immediate impact, of course, is higher input costs. Of course, you can see that red line rising rapidly a few years ago. What was that? That was the explosive inflation. So companies, of course, felt that as well.

So, Blake, what might this mean on the Federal Reserve front?

Blake: Yeah, well, the Fed is always looking at two factors chiefly in deciding what interest rate to set for the for the economy. They're looking at inflation, as you just mentioned, which they want to be running at a stable 2% rate, and they want employment to be maximum. They want the unemployment rate to be low, and they want job growth to be as much as we can get without running too high of an inflation rate due to too hot of an economy.

So what the Fed is contending with is an enormous amount of uncertainty and of really competing factors here. So as we just saw, the inflation rate is too high. It actually has been above the Fed's 2% target consistently for 4 years. And with tariffs coming in and the economy potentially slowing down, the forecasts are suggesting that the unemployment rate is actually set to rise. So we have both of these objectives moving in the wrong direction. What we're seeing from the Fed is that they're still retaining a bias towards cutting interest rates, which they have been moving towards for several months now. The Fed has been on pause since conducting a 1% decrease in the short-term interest rate last year. And markets have been wondering when is the next interest rate going to come, and how much of a reduction are we going to get? Over the last several weeks, what we've seen is the Federal Reserve communicating and markets bracing for fewer interest rate cuts that are coming at a later date. And why is that? I think it's because what you just showed on inflation. We are not quite at a point where the Federal Reserve is going to be comfortable reducing interest rates with inflation still considerably above its 2% target. So specifically what we're looking at right now in terms of what markets are pricing is about two quarter-point interest rate cuts coming later this year. That's down from four just a couple of weeks ago, and then a soft and steady decline in the federal funds rate from there—not getting anywhere close to the very low interest rates that we saw in the decade of the 2010s.

Phil: Certainly in a new regime it feels like from a rate perspective, that the exception, historically we'll look back, is that decade after the Great Financial Crisis and very low rates. And maybe now we're in a place where rates are higher for longer.

Blake: So going back to that split between inflation and employment, what we're seeing on the labor market front is very healthy job growth. The unemployment rate is at 4.2%. And as we're showing in this exhibit here, monthly job growth is printing above what we call the estimated break-even rate of job growth. The economy needs to create about 100,000 new jobs a month in order to keep up with population growth and to keep the unemployment rate stable. So we're still adding more jobs than is needed. So the labor market, many would say, is quite healthy.

What's going to happen from here? As we mentioned in that slide that showed projections, forecasters are expecting monthly job growth to slow from here. And what's going to be very important is companies are contending with higher costs and uncertainty. Are they going to deal with higher costs by slowing down their hiring, which would lead to fewer net-new jobs created? Are they going to resort to outright layoffs, reducing their workforce? That's something that's always happening month to month, but we would be looking for a big increase across the entire labor market. And these are questions that we don't quite know the answer to. We're paying a lot of attention to comments directly from companies, particularly in their earnings releases. And there's been a little bit of an uptick with concerns about labor costs and maybe resorting to reductions in workforces. But we're not seeing anything today that suggests that layoffs are substantial and are going to lead to a deteriorating labor market.

Phil: Yeah, this is that hard-versus-soft data question, right? At least on the labor market, hard data has been incredibly resilient to this point.

Blake: It has, and until or if it weakens, then with inflation running above target, as we just talked about, it's going to be very hard to see the Federal Reserve reducing interest rates with labor markets still strong. So if we're looking for interest rate cuts, then I think we're going to have to see, unfortunately, some degree of labor market weakening. And if we don't, then expect the federal funds rate to stay, pretty flat.

Phil: Look, that might be a good problem to have. If the Fed’s on hold, it likely means that the labor market remained really resilient, which we would love to see.

Blake: Absolutely. With a strong labor market, it's no surprise that we're also still seeing consumer expenditures running at a pretty healthy pace. I would note over the last few months, we have seen an uptick in the goods half of Personal Consumption Expenditures versus the services. Some are attributing that to a stockpiling effect before tariffs took effect. We have seen some of that in the microdata that we follow. So there is a question of, is there going to be some kind of payback from that in subsequent months? But the short answer is that on a nominal basis, not inflation adjusted, we still do see consumers spending at a pretty healthy pace. But we are also seeing not just from anecdotes but from actual data, we are seeing evidence that a lot of households are spending down. They are moving out of higher-quality, more expensive brands into safer and lower-cost brands. So we're seeing households adopt a more cautious stance, which I think makes a lot of sense given the degree of uncertainty that we talk about largely in financial markets, but all American households are familiar with.

And this point that I just made I think makes a lot of sense given what we're seeing in household expectations for future economic conditions. This is a very interesting data point that we follow closely that goes back several decades. So it provides a rich history. What it is is, we have a survey question that asks a broad range of questions to households about their current and their expected economic conditions, inflation and earnings and stock market. And they're all compiled into one index. And what this survey is telling us is that this month, we are at the second-lowest print on record for households expectations for future economic conditions. The only time where actually this index printed at a lower level was very briefly back in 1980 when inflation was skyrocketing. So there's no getting around it that households are concerned and they are going to be reluctant to take risks. This can lead to lower spending in the future.

And we have to balance this with what we know statistically and from real economic studies that shows us that, as you've said a few times, Phil, this softer data, survey data, does not always directly feed into the real outcomes that we care about. At the same time, it's impossible to ignore such a stark decline here. And it puts us on alert for things that we're going to care about for the economy this year, particularly around household spending activity.

Phil: It's a reminder how important the labor market is going to be to all of this. In the end, people tend to spend if they have a job, right? And that's going to be the real question. But clearly, sentiment has fallen, as I'm sure you all have heard in the news.

As we flip ahead, more survey data. What about inflation expectations, right? Household expectations of inflation over the next 5 years and the next year, they have moved rapidly up. As you mentioned, we've seen a pull forward of goods purchases. People are paying attention. I think sometimes we don't give the consumer enough credit that they are paying attention. Does headline risk feed into this? One hundred percent. And if we see tariff rates come down, which they already have to a great degree, could this improve? Yes. But if you are the Federal Reserve, you have to think about inflation expectations, not just the real data, and expectations have moved the wrong way. This is something we are watching very carefully. Of course, we all hope to see it come down.

What else is impacting the consumer as we flip ahead? The housing market. We haven't talked housing in a little bit in this forum. Where are we on affordability of housing? This looks at everything from interest rates to price appreciation, et cetera. The answer—affordability is still very low. I know this is something near and dear to your heart, Blake. And why is that? We still have mortgage rates are elevated. No reason to think those are falling anytime soon, given that the 10-year Treasury remains elevated, at least relative to recent years, not relative to long term. And of course, that's worse for first-time homebuyers. If rates are elevated, a home price appreciation—which if you look at Case-Shiller data, for example, continues to rise nationally—affordability remains low. This is something that's hard to imagine changing rapidly anytime soon. This is something we hear a lot on the road, that it is just very hard to buy a home. The truth is, nationally at least, we have a housing shortage. A lot of that goes back to after the financial crisis in which a lot of developments were not built because we had had so much dislocation in the US housing market. So this is where we stand in terms of the housing market, still a challenging market. We will point out that we are seeing month supply improve, and we have seen time on the market improve. So there's some signs of modest loosening, which could certainly be a positive in the market. But affordability is low. No other way to put it.

There also are some underlying signs of strain as we flip ahead. This is something we've mentioned before, but we do think it's important. We are not a country made up of one consumer, right? So when we look at spending, that's an aggregate. The truth is, something we have shown previously is, high-income earners have continued to grow their spending in real terms and inflation-adjusted terms. Lower income have not. Essentially have not grown their spending in 3 years. What did we see when inflation first skyrocketed a few years ago is we saw folks access their credit cards. If you live paycheck to paycheck, what is that incremental use case? Well, that's your credit card, right? Not too surprisingly, we are seeing credit card delinquencies rise—that has been continuing for some time now—and auto loans as well. So when we talk the aggregate numbers, just know that we are very cognizant that there is some strain under the hood of the consumer. Again, we can't say it enough. It is why the labor market matters so much, is that, do people have a job? That is the number one thing we are watching, and we are watching things like weekly jobless claims closely to monitor that.

So let's turn to the market now and talk about what we are seeing. So first of all, here, as a reminder—we've shown this table before—but we have US, international, in the equity space, fixed aggregate and municipal bonds. What have we seen since April 2nd, which was termed Liberation Day. The truth is we had this incredible drawdown, but now markets are up. If you're looking at equity markets, at least, are up since Liberation Day. Fixed income has sold off since Liberation Day. Why is that? Rates are higher. Remember, rates go up, fixed income goes down. Since the all-time peak, February 19, in the US, stocks are down about 3% from that all-time peak. Remember, at one point that was 19%. We'll dig into that more in a moment. But what's interesting is year to date, the US stock market is now up slightly. Interestingly, all these periods, look at international developed really outperforming the US. Emerging markets outperforming, nowhere near to the extent of international developed, but outperforming. Fixed income is up year to date when you look at the aggregate. Municipal bonds are the laggard, and we'll talk about yield there later. But amazingly, the market really had quite a V-shaped recovery here. Does that mean we're just going up in a straight line from here? Probably not. We'll talk about that as well. But nonetheless, you can't ignore that the market has had a pretty incredible recovery.

Why don't you dig in on the US market side of that, Blake?

Blake: Yeah, as you mentioned, we saw a 19% drawdown in the S&P 500 from the peak down to the trough shortly after the announcement of the new tariff situation in the US. That's less than a percentage point from what we would technically call a bear market. What's incredible is not just the speed at which that happened. There were a few days with such large declines in the S&P 500 index that they actually ranked among the highest 1- to 2-day sell-offs in the nearly 100-year history of this index. But actually, what surprised me even more was the speed of the rebound. So look at how we sold off 19% on a huge surprise and what the market took as negative information in the month of April. But just by signaling that the administration was open to reducing tariff rates and not to mention other factors like a strong Q1 earnings season, we always want to reiterate that politics and policy are an important factor, but they are one factor that matter for equity markets.

But let's be real. Largely, this was an improvement in sentiment in the global trade and the global growth situation from that change. The other point that we want to make here is that at First Citizens, we view equities as a long-term asset. And despite moves like a minus 19% change in just a couple of months, we do want to draw attention to the duration and the size of growth, the amount of growth in the bull market that had elapsed since October 2022 when the S&P 500 is up 73%.

Phil: It's incredible. Quite a run.

Blake: So let's spend a little bit more time talking about this huge sell-off and rebound. We, time and time again in this forum and in client conversations and basically every time we talk about markets, we reiterate some of our core views, which is things like it's time in the markets and not timing markets that leads to the best long-term returns for investors. And what we saw in the last 6 weeks is real evidence that this is actually the case. This isn't just a nice talking point. We saw exactly in reality some of the actual market reactions that we talk about of not, specifically in this instance, of not wanting to miss the highest daily changes in the S&P 500. We presented a chart that shows what happens to a long-term portfolio just by missing a few of the best days in the entire life of a portfolio, and it's permanently impaired by missing just the best days.

So as we know, look at the far right-hand side of this exhibit. We had in a 1-month period, starting on April 7th, we had a 13% decline in the S&P 500 over 1 month, 22 trading days. That ranks the 78th-highest 1-month loss since 1990. There have been almost 9,000 trading days since 1990. The 78th-biggest decline is what we just experienced. So that is, quite literally you can see this chart, is way in the tail of experiences. So you were right to think if you're watching that happen, this is unusual. This is extreme. It absolutely was. But what we can see through May 12th, the 1 month ending on May 12th, do you know what was actually more extreme and more unusual was the rebound. So in 1 month, in 22 trading days, we saw a 17.3% increase in the S&P 500. Out of almost 9,000 trading days, that was the 16th-highest 1-month gain. So we thought on the way down, this is remarkable. We rarely see such a steep decline in the equity market. But as we continually try to emphasize to our clients, we cannot time these markets because if you can time it on the way down, good for you. But there is even a more important element there, which is knowing when to come back in, and very few or no investors can get that right. And if you miss this recent rebound up, you miss some of the largest increases in the S&P 500. So it was just a remarkable 6-week period.

Phil: I love this chart you created, Blake, and it really is a reminder that this has been quite a year in terms of uniqueness versus history. So let's talk valuation in the S&P 500. You often hear, and we've had this incredible rally, the market's still expensive, right? It's something we talk a lot about within the capital management group, 21 times. A few things I'd point out here, and this is a chart we show often because it's very important, this is price-to-forward earnings, right? So what are you willing to pay for a dollar of forward earnings, expected earnings? So when you're high here, you're expensive. When you're low, you're cheap.

A few things to remember. First of all, the market rarely trades at the long-term average, right, valuation. So you'll hear folks say, hey, the market's expensive or cheap versus history. That doesn't really tell you much, because it can be cheap or expensive versus history for a decade, as we see in past periods. But we are expensive. So let's talk about the microstructure of the market as we flip ahead.

Yes, we are seeing the largest names, they're expensive versus their recent history, say last 20 years, the top 10 names. This includes things like the Magnificent Seven. A couple of things I point out. First of all, those largest names are cheaper than where they were, right, because they've underperformed. But they are expensive. They are pulling the market up from an expense perspective. A lot of those companies you could argue should be expensive, right? Incredible pricing power, fortress balance sheets, et cetera. When you look beyond the largest 10, 11 to 500 here on the same price-to-forward earnings metric, you'll notice that not that expensive over the last compared to its last 10 or 15 years. We continue to think that there are good companies in the US outside the top ten—if you look at measures like gross margins, that is the case. It is not that the entire market's expensive. It's that the parts of it are expensive, and they might be for a reason. So valuation might be a little bit overstated as the only indicator that matters.

Let's talk fundamentals from an earnings perspective. What we see in first quarter of 2025 earnings growth was 13.6%. That well exceeded expectations that were around 7% earnings growth in the first quarter earnings season. That beat—usually earnings do beat, right, we see conservative estimates and earnings beat each quarter. But that beat was more than average, about 78% companies beat on earnings. So the first quarter, when you think about the market rallying, some of it's that fundamentals in the first quarter were maybe better than we thought, right? Coming into some of the tariff dislocations that began particularly in April. Earnings expectations for 2025 at 9%. That was double digit not long ago. So clearly there's been some revisions in future quarters. We did see that during first quarter earnings season. 2026 at 13.4%. Honestly, it's pretty early for 2026. I wouldn’t read too much into it. Something we are watching closely, though, when we talk about the impact of tariffs is, we have seen margin expectations start to tick down a little bit. That's on this chart on the right side. Still very elevated versus history. But the direction of travel does matter here. This might be, from a market perspective, the most important chart in this entire deck. Look, markets pay for margin expansion, right? If you are going to eat some of that tariff, right, pass some of it to your customer but eat some of it, there's only one way that happens. That is through margins, right? While you redefine your supply chains, et cetera. This is something that we have an eye on and does certainly concern us.

So let's talk about our price target. We adjusted our price target in March from 6,400 to 6,300. Pretty modest adjustment. We have not changed it since that time. Of course, at points the market was down 19% peak to trough. This price target looked very high. Right now, our base case next 12 months—remember, this is not a year, this is a 12-month price target—is up about 6% from where we are today. Look, a lot of good news is priced into this market. We don't expect the market to move in a straight line to 6,300. But this is what the fundamentals are telling us.

If you're more bearish, you could see our bear case here. That indicates really a contraction from these levels. And then if you're more bullish, you can see our bull case, which indicates, of course, more earnings growth, et cetera. So let's pause there on equities and talk fixed income for a little bit, Blake.

Blake: Yeah, what we're showing here are corporate bond spreads, and corporate bond spreads are a sort of a risk, we can view it as a sort of risk premium of how investors view the corporate sector. So when we see the high-yield corporate bond spread at 400 basis points, that means that investors are demanding a 4-percentage-point spread above the same Treasury in order to take on that risk. So is the risk that we're seeing in this market high or low? It is still pretty close to the lowest that we've seen in a decade. There are some kind of technical factors of why it might be a little bit lower, but it is safe to view this as the market is not seeing a huge amount of risk in the market. This is in the face of, go back to the beginning of our presentation here, the highest tariffs in 80 years. Higher interest rates, lower growth expectations, higher inflation.

So there is a question in my view of, are markets a little bit priced for perfection? Or more specifically or more precisely, are they just priced for a lot of good news going forward? And that doesn't have to be wrong. Think about in 2023 and 2024. Markets got good news time and time again and were surprised to the upside. But I think it is important to note that one thing we can take away from this market is the possibility that a lot of investors are expecting things to turn out quite well from here. So if the news does come in incrementally negative, then we might see an increase in these spreads.

Phil: And much like the equity market, we saw spreads increase following Liberation Day and then even Mexico and Canada concerns around trade before that. But they've come back in, right? Just as we've seen the equity market rally, we've seen quite a reversal. And even that spike, you did not hit levels that you saw in say 2020 or even the summer of 2016. So pretty interesting that fixed income is not signaling alarm bells at this point.

Blake: Yep. What's happening on the other side of fixed income and in treasuries, what we're seeing is longer-term interest rates like the 10-year Treasury yield have stayed roughly where they started the year or they haven't stayed, but today they have returned to where we started the year at about 4.4% to 4.5% on the 10-year yield on 10-year Treasury note. Where we have seen a difference, if you look at this gold series here, the latest date we have available. At the shorter end of the curve, 1-, 2-, 3-year Treasuries, we've seen those yields move down more. So we've seen a steepening in the yield curve. Think back to what we said a few minutes ago about Federal Reserve expectations. This is playing into how we're viewing the shorter-term treasuries here. But I think the big takeaway from this chart is not much movement in the 10-year yield. That's our benchmark rate for things like mortgages. That's what a lot of investors are looking at. And that yield reflects how investors view the health of US government borrowing and such. So we're still seeing interest rates that are elevated compared to recent years and the state range bound this year.

Phil: And certainly have had a wild ride to get here. But it's amazing the degree which not all that change from earlier in the year.

Blake: And as a whole, fixed income, we still believe offers attractive yield for investors now. As we mentioned, 10-year Treasury between 4.4% and 4.5%. The aggregate bond yielding close to 5%. Where we have seen an uptick in yields particularly has been in municipal bonds. So think back to, as you can see here, we haven't seen a whole lot of movement in treasuries but we have seen a much higher increase in municipal bonds. Back in April, we saw some of the wildest swings in municipal bond prices, actually, our fixed-income analysts tell us on record. But as a whole, we still view fixed-income yields as attractive.

Phil: Certainly a reminder that balance in portfolios matters more today than when yields were very low. There is yield within fixed income. Remember, the summer of 2020 the 10-year Treasury was yielding half a percent, right? We're nine times that. So certainly fixed income shows some attractive income generation, which was not the case a few years ago.

So to the point of something you discussed earlier ago about not missing some of the best days in the market, this is a chart we like to show. And interestingly, we in April actually saw it play out. So if in 1995 you had $10,000, through 2024—$10,000 invested in 1995—if you were fully invested, that generated $130,000, right? Which is a lot. And remember, this includes the tech bubble bursting in 2000, the Great Financial Crisis, the pandemic. This includes some pretty substantial moves in the market, even if you look over the long term and you were still at $131,000. If in those thousands of trading days you miss just the 5 best days, that is 37% less to $83,000. If you miss the 10 best days, that falls to $60,000. And you might say, well, why is that? Well, nearly half of the S&P 500's strongest days occurred during a bear market. Another 28% took place in the first 2 months of a bull market. So every once in a while, the market shows us something that's incredible. On April 9th, the market rallied in 1 day 9.5%, right? Remember, April 2nd, we saw this big drawdown. April 9th, we saw the 90-day delay in reciprocal tariffs. The market like 9.5% 1 day. That is a good year of return, right? 9.5% a year I will take any year. That happened in 1 day. If you miss that day, of course, it really impacts the return of your portfolio. So the recent point would—not to belabor it—but as Blake pointed out, the recent rally is certainly exceptional and a reminder that it's very hard to know when to sell and also when to buy.

Blake: I think it's amazing. We've shown this chart month in and month out, and we got to experience it.

Phil: That's right. Absolutely. Great point, Blake. With that Amy I'll pass it over to you.

Amy: Yeah, thank you both for all of that information and going into such a deep analysis of what's happening. Just a reminder to everyone, if you are interested in staying informed throughout the month, the best way to do that is to get onto our subscription list so that you get all of our publications throughout the month as soon as they're made available.

Let's jump into questions really quickly. Phil, no surprise on the first question. We definitely have seen, as you just reiterated nicely, it's been a historic time for market volatility. Do you see any sign that the volatility level could smooth out in the future?

Phil: Well, yeah, I think there's a few things to remember. One, something we say all the time but we were reminded of is, volatility can be up and down, right? Often we associate the word volatility with the market selling down, but we have seen an incredible rally. We've gotten this question a lot. Do things settle down over the summer? My instinct is no, and that does not mean the market sells off or rallies sharply. I just think we're going to see some bumps. Why is that? One, we have legislation going through Congress on the tax front. That is something people are watching. Two, tariff delays. Remember, the reciprocal tariffs was a 90-day delay and China was a 90-day delay. This is not resolved. That is something I would watch. And then thirdly, and maybe more importantly—maybe I should have led with this—is second quarter earnings season, right? That will begin in earnest in July and leak into August. How do companies handle this, right? Essentially a trade embargo with China. I think that company results will be extremely important in the second quarter. And then finally, often in the summer, particularly August, volumes are pretty low. So it's not uncommon to see the market kind of do strange things, particularly late in the summer when folks are on vacation. So I would love for it to be a docile summer. I'm cheering for that. But I think there are reasons to think that we do bounce around, even though, remember, our price target is up over the next 12 months.

Amy: And Blake, Phil mentioned the tax policy. As of this recording, there's a lot happening in Congress around the tax bill. We got a lot of questions about how that might impact the deficit and the economy as a whole. Would you mind speaking to that a little bit?

Blake: Yeah, we have two major revenue policies in flux right now. The first is tariffs. Tariffs are going to likely raise hundreds of billions of dollars a year in government revenue from US businesses. And we have additional tax cuts on the table that are being debated and legislated in Congress as we speak. So on a macro fiscal basis, those are offsetting. We have a huge tax hike from tariffs, and we're looking at a substantial tax cut going through Congress. So on a fiscal basis, how is it going to affect the overall government borrowing position they're offsetting? I've seen analysts saying that one's going to outweigh the other. I've seen other people saying the opposite. It depends on what Congress actually passes. And that number is not going to be decided until it makes its way through the final chamber for sure. But one point that you'll recall we have made since last fall, last winter, is that we have one of the narrowest margins in the House of Representatives in history. So it is always difficult to pass anything through Congress that's this substantial. But getting every single member of the majority to vote for it has always been an obstacle and is going to be until the end.

But to answer the question about the deficit impacts, we have offsetting variables here, and they are going to affect very different constituencies. I always try to think about this not in terms of how is it going to affect big companies in the S&P 500 but also how is it going to affect smaller businesses? So if you have a huge increase in your costs from tariffs, if you're not getting a huge tax cut from the policies that are going through Congress, then you're going to be worse off. Vice versa, if you're not affected by the tariffs so much but you do benefit from tax policy, then you're going to come out ahead. For the entire economy and the entire borrowing stance, they're going to be roughly offsetting.

Lastly, to your point about the deficit, it is increasingly becoming the consensus that the US borrowing position is untenable. We have a deficit that is one of the largest in history in peacetime and outside of a recession. And it's actually growing on a year-on-year basis despite a lot of the cuts that we've seen going through. So that's another obstacle that's going to make it potentially more difficult or the debate around passing tax cuts to be difficult.

Amy: And Phil, coming back to market volatility, one of the things that seems to be setting off some alarm bells is the large amount of volatility in the bond market. Can you talk a little bit about how yields are impacting the bond market?

Phil: Yeah, look, the 10-year Treasury, just as a benchmark, has moved around quite a bit this year, around 4.5%. That is actually fairly materially below where we were even in January. But the hope, of course, has been that yields would fall. I don't see much reason why yields aren't sort of in the range they've been in the last 12 months, right? We've had periods of sub 4%, periods of near 5%. But I think they remain elevated for some time. Why is that? We have a Fed on hold, right? That's the front end of the curve. But more importantly, to what Blake mentioned, if you're worried about the borrowing position of the US government, why would rates fall sharply? What gets rates down may not be what we want, which is, yes, if we have a severe economic downturn, I still think that US Treasuries are the global safe-haven asset. You would see a rally. Rates would fall. But as we can all think back to the depths of the pandemic or the Great Financial Crisis, when rates are falling for that reason, no one's that happy. You want rates to fall because inflation is coming down and the term premium is coming down, et cetera. I end up talking about this a lot on the road. Unfortunately, I don't have great news. I do think that rates at these levels are kind of the norm. To be clear, 4.5% 10-year Treasury yield is not high by historic standards. It's pretty normal by historic standards. It's high compared to where we were from the Great Financial Crisis through the pandemic, that decade. 4.5% is pretty standard. What I have observed among our clients is businesses have sort of adjusted to this world, right? You may not like it, but you adjust to the fact that risk-free rate has moved up. It of course has implications for things like mortgage rates as well. We all would love mortgage rates to go back down to extreme lows. But that was the exception historically, not the norm. I think we are now in a world where rates that we viewed as normal up until the Great Financial Crisis of 2008 and 2009 are here potentially to stay outside of a major dislocation, which none of us want.

Amy: Well, thank you both for going into those answers. And to our listeners, we want to thank you, as always, for trusting us to bring you this information. That's something that we never take for granted. We hope you have a safe and happy Memorial Day weekend, and we will see you back here next month. Thank you.

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Authors

Brent Ciliano CFA | SVP, Chief Investment Officer

Capital Management Group | First Citizens Bank

8510 Colonnade Center Drive | Raleigh, NC 27615

Brent.Ciliano@FirstCitizens.com | 919-716-2650

Phillip Neuhart | SVP, Director of Market & Economic Research

Capital Management Group | First Citizens Bank

8510 Colonnade Center Drive | Raleigh, NC 27615

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

Blake Taylor | VP, Market & Economic Research Analyst

Capital Management Group | First Citizens Bank

8510 Colonnade Center Drive | Raleigh, NC 27615

Blake.Taylor@FirstCitizens.com | 919-716-7964

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