Making Sense: July Market Update

Making Sense

Market Update | July 2026

Recorded on July 22, 2026

Amy: Hello, everyone. I'm Amy Thomas. Today is July 22, 2026, and I want to welcome you to the First Citizens Wealth Market Update series. Today, Phil Neuhart and Blake Taylor will take a deep dive into what's happening in the markets and the economy.

As always, 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 should not be considered as tax, legal or investment advice. And, Phil, with that we're ready to go, so I'll turn it over to you.

Phil: Thank you, Amy, and thank you everyone for joining us again this month. And Blake, thank you for joining this month.

Blake: Glad to be here.

Phil: In place of Brent. One more time, it's really great to have you here. So what are we going to cover today? Well, one, the economy. There's plenty going on—geopolitics, inflation, the Fed is meeting next week. What is going on in terms of Federal Reserve policy? And then, of course, everything artificial intelligence. This is both economic and market oriented, but we want to talk about artificial intelligence with you all.

And then from a market perspective, of course, equity markets, corporate earnings—we're in the middle of an earnings season. I want to talk about that a little bit in terms of expectations. Fixed income, which remains quite interesting as an asset class. And then some tenets to remember in terms of long-term investing.

So let's jump right into the economy, Blake.

Blake: Yeah, well, the geopolitical situation in the Middle East has re-intensified and it's a very significant issue, very broad ranging, but we're going to focus on the financial-market impact this morning and that largely relates to once again a major disruption to global energy supplies.

So recall that back 5 months ago when this war started, oil stopped flowing through the Strait of Hormuz to the tune of about 20 million barrels a day—or 20% of the world's oil supply. And that's what you see in this graph here. As it used to be about 25 to 30 crude oil tankers that moved through that strait and that fell to zero.

Over the months since the ceasefire agreement—or the weeks since the ceasefire agreement—that did kind of perk back up, but now that hostilities has resumed, we are back basically to zero. So if you think back in March and early April when oil prices surged, they surged by about at most 80 to 100%, which is an enormous amount, but given the extent of the supply disruption, honestly relatively moderate. What kept that in check? It was probably at least three things.

One, oil supplies and inventories were providing a huge cushion to the global oil market in February. We had a lot of excess inventories, supply was really pumping. And second, Saudi Arabia and other countries had these big mitigating factors that acted as another major safety net. Saudi Arabia started pumping 6 to 7 million barrels a day, 750 miles from the Persian Gulf to the Red Sea, accounting for maybe 25 to 30% of that shortfall.

And then third and most surprisingly, China just stopped importing as much oil. China's the largest oil importer in the world, and for some reason or another, their halt or slowing of those oil supplies helps act as a release valve as they probably switched to coal or just lowered their demand.

So now that we're back to this supply crunch, we're going to be looking for all three of those things to remain in place to keep a lid on prices. But unfortunately, they're all a little bit less certain, especially now that inventories and supplies are quite a bit tighter and we're seeing a little bit of risk out in the Red Sea for those oil supplies coming out of Saudi Arabia.

But it's not just oil that matters for the economy, of course. I don't know about you, but I put refined gasoline in my vehicle. I don't keep barrels of crude oil in the garage. What people actually consume are gasoline, diesel and jet fuel. That's what businesses and households consume and that's also what feeds into the inflation outlook, which again for financial markets is what we most care about.

So as many people probably noticed, oil prices fell in late June and into early July until those hostilities resumed on July 9. Gasoline prices did not. I don't know about you, but I didn't see gas prices falling all the way back down to where they were.

Phil: Yeah, a moderate fall as you can see here but nowhere close to the extent of the fall in crude oil prices.

Blake: And a major reason for that is again, it's refined products that we use, and refining capacity in the United States and Western Europe has not been increasing. It's actually been getting tighter as more refineries are coming offline. And it's also not just oil that moves through that Strait of Hormuz, it's also a lot of gasoline and jet fuel and diesel. So what we saw was what was already a tight supply crunch on the refining side has now gotten even tighter. This is what matters for the inflation outlook, and unfortunately, unless we see another drawdown in those oil prices, then this is going to be yet another thing pushing inflation in the wrong direction.

Phil: So what about inflation? If we look at Consumer Price Index, this is headline consumer prices. So it includes everything, including gasoline and other refined products.

Of course, we had the massive spike in inflation after the pandemic, the 2022 era peaking near 9%. And inflation in recent years has remained above the Fed's target of 2%. As we'll talk about in a moment, inflation's cumulative, right? Even if inflation's running at say 3, it still is well above the Fed's target, and that is in addition to what you saw in the prior year. And we have seen, of course, a spike up in headline inflation. As you can see the dark blue line here this year, why is that gas prices went up, right? That's really the story.

If you look at the swaps market, which is really just a financial market where you can see implied inflation rates based on the market and market expectations, we've seen quite a move here. That light dashed line there at the bottom, that is where inflation expectations according to the market, not professional forecasters, according to the market was before the war. That, of course, moved rapidly to a peak in June, as you can see in the purple line, and now it's kind of in between.

But the real story here is that if you look through the end of this year into the beginning of next year, markets are expecting that inflation stays elevated. And why is that? Uncertainty, right? When you showed that Strait of Hormuz chart, it would be surprising to see anything different. It is showing that headline inflation remains a major risk and something that our clients are going to be focused on.

We're lucky enough to spend a lot of time on the road, and inflation is something that consumers are mad about, honestly, and really concerned about in terms of their spending. And why is that? Well, one, as I mentioned, consumer prices and inflation is cumulative. So if you look at consumer prices here, we're up, what is that, 26% since the beginning of 2021. And you look at the gold line, you say, well, wages are up a little bit more than that. Well, that's true, but look at 2022, 2023. The truth is consumer prices were rising faster than wages, and if there has been a catch-up in wages, it's really been more recently.

The other issue when you think about consumer behavior is we are all anchored, certainly I am, to the experience before the pandemic when inflation was low. And if you took wages, the wage growth pre-2022, this dashed gray line, you would see wage inflation that exceeds consumer price inflation much more than what we're seeing in this current period.

So you think about consumer behavior. We were used to wages exceeding consumer prices when inflation was low. Well, now inflation's high, and wages are not keeping up to the same extent or exceeds the same extent they would have otherwise. This is really driving frustration and really is hurting a part of our consumer segment.

Blake: Yeah, it's really not too much to ask to have your wages growing beyond inflation. That's always been the pattern, being able to purchase more with your wages.

On the Fed, at the start of this year, markets expected the Fed to cut rates two to three times this year. Why was that? Disinflation was the trend. As you just showed, back in February, markets expected inflation to continue to trend back closer toward the Fed's 2% target. Also the labor market looked a little bit a little bit more fragile, and the market's expectation of the new incoming Fed Chair was that that person would lean a little bit dovish. They'd be more likely to cut rates than to hike rates.

None of that has played out. Of course, inflation surged from the beginning of the Iran war, the labor market has stayed relatively intact, and, of course, the new Fed Chairman, if anything, might be the one who's pushing the Fed in a hawkish direction.

Phil: He sounds pretty hawkish, doesn't he?

Blake: So none of those factors is the case today. And there's also maybe an additional one that people hadn't thought about at the start of the year and that's—we're going to hear this a lot this morning—that's AI. Compared to the start of the year, markets are now expecting companies to spend hundreds of billions of dollars more on AI CapEx and buildout. A lot of that is in computer chips, and computer chips do not just go into data centers. They go into smartphones, consumer electronics, cars—you name it, there's probably a computer chip in it.

So now companies and households are fighting for the same limited supply. That's putting, as we'll show in a later slide, that's putting an enormous amount of upward pressure on that one commodity input that's going to make its way all the way through into consumer prices. So just yet another—one supply shock after another—just another thing is exerting a little bit of pressure upward on that last percentage point of inflation trying to move to 2 to 3, making that last mile the hardest.

An interesting thing that came out of new Fed Chairman Kevin Warsh's testimony to Congress last week was talking about money. He said, "I have this, sort of, old fashioned view that monetary policy has something to do with money." So 50 years ago, cue Milton Friedman's famous quote, "Inflation is always and everywhere a monetary phenomenon." Or that's a way of summing up too much money, chasing too few goods leads to high inflation—or maybe a little more technically, growth in the money supply, exceeding growth in output is going to lead to higher prices.

Well, basically since he uttered those words and after the 1970s and early 80s inflation went away, the relationship between money and inflation, sort of, broke down. And the halls of central banking and academia, people kind of pushed money supply measures off to the side and maybe it got relegated to some cocktail party conversation of "Are you a Keynesian or are you a monetarist?"

Phil: Sounds like a fun cocktail party.

Blake: But in the most part, it didn't really play into the policy discussion really all that much. Kevin Warsh has brought money back into the conversation, not necessarily saying this is exactly what he's going to follow, but in a way that it hasn't been looked at in decades, expect to see this maybe in a little bit more of the conversation when it comes to monetary policy and even into market analysis. And as you can see, money supply growth is starting to climb back higher.

Phil: So in that context and thinking about the Fed, well, we talked about one side of the Fed's mandate, which is price stability or inflation. And the truth is that's kind of what the market's been talking about. But the labor market is another side, and we've been in this low-hire, low-fire environment now for years, and that is extremely rare. If you look at this long-term chart of the unemployment rate, notice that when it starts to rise, it normally keeps rising. And in fact, rises pretty steeply historically.

Well, that's not been the case this time. We had a rise from what was really historic lows with that very tight labor market after the pandemic, and we've kind of been moving sideways for a couple years now in the sort of 4 to 4.5% on unemployment, which historically is quite low. The last time we had this sort of sideways move was really in the 1960s.

This is very rare and speaks to a labor market that is good, not great—kind of middle, right? That is where we are, and then we're seeing that in other data as well as we flip ahead here. If we look at the number of job openings per unemployed worker, remember after the pandemic, our clients were saying, "We cannot find workers, and when our workers leave, they're getting incredible pay raises."

The reason was there were two job openings for every unemployed person. If you left a job, depending on what industry, there were two jobs waiting for you. Well, that is now an equilibrium at about one, right? Again, low hire, low fire.

The other thing we are watching closely is there is real divergence among sectors here on the right side. Healthcare has been really important for any job growth that we have seen. Hospitality has also been a contributor, but healthcare is really number one. This is true anecdotally. Any of you who speak to people who work at hospitals, right, we still see shortages there. What has been a drag has been information and technology.

Now there's a couple things here. One, potential impact from AI. That may be a bit overstated, but certainly is an impact. The other thing to remember is during the pandemic and after the pandemic, a lot of tech companies really did overhire, and we have seen some layoffs that were basically just laying off those you hired in the 2020, '21, '22 timeframe.

But it really depends what industry you're in. If you were in tech, unless you're in AI specifically, it probably doesn't feel that expansionary. Whereas if you're in healthcare, you can't find enough workers.

Blake: Yeah, under normal times, we would like to see all those lines trending up above the X axis. And if you remove healthcare, then there's basically been no job growth over the last couple of years.

Phil: So what does this all mean for the consumer? Low-hire, low-fire has resulted in consumer spending that is okay. Inflation adjusted around 2% growth. Something we talked a lot about, we won't dig in too deep here, is that there really are two consumers though, upper middle-class, upper-class spending has been robust, even inflation adjusted. Lower-income folks, that has not been the case. Why is that? Inflation. Which is why inflation is so harmful. So consumer spending's okay, let's say, 2% inflation adjusted.

But what has been the real turn in terms of expectations has been AI. So if you look at the right side, this is the evolution of 2026 growth forecast—what professionals were expecting in terms of economic growth this year.

You can see GDP, the highest number was what? February, March, right before the war. That has come down a little bit with consumer spending. Remember, roughly 70% of GDP is the consumer. And that consumer spending, that gold bar has come down. Why is that? Inflation. Gas prices go up. That does hurt the consumer.

But what has changed dramatically and continues to march higher is private investment, and this includes AI. It includes data centers. That blue bar—this is just not normal. We've done this for a long time. Rarely do you see this, sort of, step function move higher.

By the way, we're in the middle of an earnings season, and we're going to get more news from hyperscalers, and that could find its way into this data to refresh even over the next month.

So let's dig in to AI, something we talked a lot about, but you cannot be a market watcher or an economic watcher and not be thinking about AI. So we're going to keep talking about it, and it remains something that the marketplace is going to as well. So let's look at CapEx spending on generative AI. This is from what we call the hyperscalers, right? If you look 2020 to 2025, it's about $1.2 trillion. Well, let's look at just 2026 and the way the estimates are changing. As of January of this year, that estimate was in the 600s. As of April, after an earnings season, it was in the 700s. As of June, it was in the 800s. And by the way, we're now going to have an earnings season. This number could move higher.

You look at roughly, what, 1 trillion in 2027, $8 trillion of cumulative CapEx 2026 through 2032. These numbers are unbelievable and really unbelievable in a historical context.

Blake: You have to go back to the 1800s to find another CapEx project that was as expensive relative to the size of the economy. So I'm pretty sure I heard you say trillion. Is that what you said?

Phil: I did.

Blake: A trillion dollars, if you spend a million dollars a day, it'll take you 2,700 years to reach a trillion dollars or alternatively, you can cut a $125 check to all 8 billion people in the world and then you'll reach a trillion dollars. That's what we're looking to spend on AI CapEx just this year.

So every investment mania over the past several decades going back over 100 years—most of them except railroads in the 1870s—has capped out around 1% of GDP, including the famous telecom buildout in the 1990s. Think about all the fiber that was laid, all the cell phone towers that were built. And that eventually did come down after that boom in 2000.

This is multiples of that. So this is going to be one of the biggest buildouts, one of the biggest CapEx projects in history. I can't wait to find out, to see what it does.

So if the railroads were the biggest, then AI is by far the fastest. So a recent study looked at these different mania booms—canals in the 1830s, railroads in Europe in the 1840s, the roaring 1920s of electricity buildout, dot com in the 1990s and then AI today. And what it found is that compared to the baseline year—so for AI they're using 2023 at year zero—by now, we're already at four or five times the spending from just a few years ago. You go back to the fastest buildouts in previous booms, it took longer just to get to 2 or 3, 4x of where we were.

Now if we take the projections that you showed a couple slides ago on that bar chart and we apply those forward, we're soon going to be looking at 7 or 8x of where we were in 2023. So in addition to being one of the largest, most expensive projects, it's also ramping up to be one of the fastest. We can't update this data fast enough because of how much is being spent and how much these companies are committing to spending in the future.

Phil: And when you think about the railway mania or buildout on the previous slide, that is as a percentage of GDP. Our GDP was a lot smaller. We were a lot less-developed country in the 1800s versus the largest economy in the history of the world, which we are today.

Blake: And where is a lot of this spending going? It is going to building these massive data centers, but it's not just the construction. Some of these things blow my mind looking at how big they are. It's not just building those structures, it's what goes into them.

And what goes into them are these computer chips. And what we're showing here are not just the processors that we've heard a lot about in recent months, but just memory chips. And this is a lot of what goes into, as we were saying before, what goes into those household and consumer electronics that are going to be competing with these data centers. So just in the last several months, just this year, we've seen 2 to 3, maybe 4x increases in these prices.

So that is a lot of what's driving these hundreds of billions in spending is the fact that it's gotten so expensive. So what happens with this—this is a result of a huge supply-demand mismatch. They're not able to create more to meet demand. So as long as demand stays there, then both the companies who are using these for the AI buildout and regular old consumer electronics and other industrials are going to be competing. Yet another thing that's going to be putting a little bit of upward pressure on inflation that we want to be headed the other way.

Phil: And we see announcements from major consumer companies, consumer electronic companies raising prices based on this. It reminds me a little bit of the pandemic era from a monetary-policy perspective where during the pandemic, there were shortages. Remember, there weren't chips to put in cars.

The Fed does not control this, right? And it's one of those things that it's the reason being a Fed Chair or a Fed Governor is a really hard job is you get blamed for inflation that you just don't really control this, right? This is an exogenous event, a data center buildout explosion that's going to find its way into consumer inflation, very difficult to forecast, really to know where these prices are going to go. A year ago, I did not hear anyone talking about DRAM prices, and now they are.

So you might have heard there's a midterm election coming up this year. It's something we're going to be talking about in coming months, of course. Often, the impact to the market, honestly, is less than you might think. It's something we will, of course, highlight for you as well, but, of course, it's something that we all are watching.

So here what we're showing is the probability of midterm election outcomes from prediction markets, from betting markets. This is not polling data. This is what pricing would be based on bets put into prediction markets. So what are the two most likely scenarios? And they're very close to each other, statistically, basically the same. It's Democratic sweep in the bold blue line here. That's Democratic Senate, Democratic House and divided Congress where you have Republican Senate, Democratic House. Those have flip flopped over the last 12 months, but are extremely close to each other—the most likely outcomes.

A very distant third is Republican sweep where you have Republican Senate and House. And then at the bottom, you can hardly see it, it's a light dashed line, is divided Congress where you have Democratic Senate and Republican House. That would, according to prediction markets, be a real shock to the system.

So when you're thinking ahead, what are markets saying? Well, markets are saying either divided Congress where you have Republican Senate or a Democratic sweep. Again, more to come on this and something we have an eye on, not something that we're going to move portfolios on, but something that, of course, can matter for markets.

So let's dig in to markets. We just spent time on the economy, but I want you all to remember that everything we're talking about in markets has a lot to do with what we just spoke of in terms of artificial intelligence and things like memory pricing.

So have that in mind as we talk about what's going on in markets. First, year to date, something that we've highlighted, and we think is really important and may be flying under the radar a bit, is year to date we've seen what we call broadening, right? This idea that only a few companies have been driving us higher. We'll talk about that more in a moment. But other asset classes and smaller companies are actually outperforming.

If you look year to date, here we're showing small cap, the S&P 500 equal-weighted index, right? So equal weighted, all that is is all 500 companies have the same weight in this index. The usual S&P 500, which is cap weighted, where a big company has a bigger weight. And then, of course, the Magnificent Seven, these big tech companies that we've all talked about in recent years.

What's the best performer? Small cap. And it's not by a small margin. It's by quite a wide margin. Next, equal-weight S&P's outperforming cap weighted, also by a notable amount. Then the S&P 500. And what's trailing? Magnificent Seven.

For all this talk of Big Tech, the truth is you are seeing outperformance not only outside the US, but inside the US, outside of just the biggest companies. This is important for a healthy market, And the reason is, is the right side, which this is since the market bottom in 2022, what has driven us higher? Magnificent Seven, by far the top performer, followed by the S&P, and then small cap and equal weight are trailing.

Just to be clear, we as investors, we have diversified approaches. We don't just go buy small cap or just go buy Mag Seven. I think the Magnificent Seven run, though, for those who are very concentrated, if you did not own these companies and you had this run since 2022, this was quite painful, and a little bit of underperformance this year does not make it less painful. So we're seeing broadening. It's good to see year to date.

Certainly, these hyperscalers have driven us in recent years. I think there is something—this is anecdotal, it's hard to prove this—but there is something to the idea that if the big companies are building a technology, artificial intelligence, that's going to benefit other companies, you have to start to see that show up in price, right?

You cannot just have smaller companies outside the Top 10 trail forever. So seeing this broadening might be the market telling us something.

It's hard to talk about AI and not think of the 1990s. I think Blake is tired of me bringing up the 90s all of the time, really daily.

So something we're showing here, and this is not a prediction or a path, it's just to give you context. Here we're showing the Nasdaq. Now again, we don't just go buy the Nasdaq, and we wouldn't recommend somebody do that. Buy the market as a whole, have all of large cap, mid and small—and the US and international as well.

But if you just own the Nasddaq, which would have been really painful for you in the unwind of the early 2000s, if you just own the Nasdaq in the 1990s—here we're showing 1996 onward—and the 2020s AI, March 2023 onward, look at the degree to which the '90s eclipses what we are seeing today. Really dramatic. So one, be careful when you say it's the same. It's definitely not the same, as you can see here, but additionally, it's a reminder, we'll talk about this more in a moment, timing these things and knowing who the winners and losers are is very, very difficult.

We don't want to see a bubble like the '90s. Is there some froth in some of these companies? Probably, but we are not at that late-90s period where really we lost all rationality.

So let's talk about actual fundamentals and then earnings, Blake.

Blake: Earnings growth are the defining factor in markets this year. As you showed, really impressive performance across various indices. That is not just sentiment, it's not some, sort of, fringe economic factor, it's not some relief valve, it is earnings growth. And what we're showing here is since the start of the year, analysts thought that total S&P 500 earnings would grow at about a 14% pace year on year.

Since then or really since the Q1 earnings season in the spring, that has been marked higher and higher and higher and now analysts expect 24% year-on-year earnings growth. And as you said, we're in the middle of an earnings season. That could very well be marked up even higher. So underpinning growth in markets and impressive returns is a healthy and robust fundamental of better earnings.

So typically, in a regular or an average year, earnings growth is about 7.6%. We're expecting in Q2 that to round up to 25, as we just said for the full year of 2026, 24%. And we're already looking into 2027 at another more than double average pace of 17 to 18%.

What drives earnings? A lot of it is—and also what supports valuations—is operating margins. And what we're showing here on the right, many of you may be familiar with this chart, we've added a second series.

Overall S&P 500 next 12-month operating margin has risen impressively to almost 21% in a really aggressive runup this year, and we'll talk about why that is in just a moment. But the reason that we added this gold line, which is the equal weight—remember equal weight is counting every S&P 500 company the same, it's a count-weighted average. The regular S&P 500 is a market-cap weighted average.

So we asked, "Is this huge run up in operating margin only due to these biggest companies, some of which are selling AI equipment at really high prices and margins?" No, it's not. The gold line has showed us that this year the operating margin for the equal weight has risen to about 15%. Not quite as much as the cap weighted, but it is not just the largest companies that are driving that higher.

Phil: And just as the cap weight is really at record levels, the equal weight is at or above record levels as well. When we talk about the broadening, right, outperformance of equal-weight versus cap-weighted S&P in price this year, you cannot ignore this chart.

So let's talk a little bit more about margins. Here we are showing the share of S&P 500 companies by market cap with gross margin greater than 60%. And why are we showing greater than 60%? For any business owners, you don't need to hear this, but for others, if you have a company and it has gross margins over 60%, that is great. That is a really good company. I'd love to start a company tomorrow that has 60% gross margins.

There's really good companies that have single-digit margins. This is really a great margin. If you look at the cap, the market cap of the S&P that has margins over 60%—gross margins over 60%—it's 40% of the market cap. That, by the way, is the highest we have on record.

What is the breakout, though? What does this look like? Well, first of all, the swing factors, particularly of late, semiconductors and equipment—that's about 20 companies. That gray chunk has risen dramatically.

In fact, it was barely any of the companies a decade ago. Also mega-cap tech and communication services, the big tech companies, that's another 35 companies, that has grown as well. That gold bar has risen. And then everybody else, the rest of the S&P, this doesn't include financials and real estate where gross margins is a tricky measure. That blue bar, yes, it has leaped lower from the peak, sort of, in the mid-teens, but really has actually been pretty sideways over the last 3 or 4 years.

So the story is, yes, there are companies joining the gross-margin party, but if you own the market, you own those companies, right? So it's this chicken and egg thing where you say, well, there's some concentration in earnings. Well, that's true, but that's why you own the market, right? It's something to think about. The real takeaway here is—there's a lot of companies with really high gross margin S&P. That is what's driving earnings higher.

So we mentioned, yes, price of the S&P 500 is up 9% give or take year to date, but earnings growth and expectations has risen even faster. So you look at valuation or in this measure we're showing is forward price-to-earnings ratio. This ratio, all it is is the price you're willing to pay for a dollar of forward earnings. The market, yes, is expensive compared to long term history, about 20 times expensive compared to where it was before the pandemic.

What's interesting is even with a market that's up quite a bit midway through the year, we're cheaper today than where we started the market—the year, I should say. Why is that? Earnings has outpaced price. That denominator has risen faster than price, than the numerator. So if you want to be technical, and I don't think you should invest just on valuation, but if you do, if you liked the market on December 31, you should like the market more today. Again, I think that's an oversimplification, but for those who really think about valuation, something to keep in mind. The market's actually cheaper today than it was when we started the year.

So what's our forward outlook for the S&P 500? This is our 12-month forward price target—unchanged at 8,000. That's up about 6.5% from where we closed on July 21. Up, I would not call this max-bullish, but the truth is when we work on our numbers that back this table, earnings are what are pushing us higher. It's not valuation or price to earnings, it is earnings. It's pushing us higher, 6.5%. This is unchanged from our last monthly report.

Blake: Some people argue that markets are priced to perfection or at least priced very well. That doesn't only apply to equity markets. It very much applies to fixed income as well. Option-adjusted spreads are near their historic tights for both investment-grade and high-yield bonds. So in other words, an investor is getting paid a very small margin to own a corporate bond instead of a relatively risk-free or purely risk-free Treasury bond.

So what that's showing us is that the market is not pricing a very significant amount of risk into the market. So we think that there are some risks out there. Private credit is something that's on a lot of people's minds. The rapid spending that we talked about with AI is showing up in some of those companies that are spending very aggressively.

Phil: And some of those companies, by the way, are financing with debt, which is not something these big tech companies have done traditionally.

Blake: But overall, for the whole market, both investment grade and high yield, are very tight, delivering a quite-modest amount of premium over Treasuries. And that's been—so where is the return coming from for fixed income? It is from the yield itself. So compared to the start of the year, if we can move sequentially, the 10-year Treasury was about 4.2% at the start of the year. By the breakout of the Iran War, yields had moved quite a bit lower. The 10-year was at 3.9%. Remember as we talked about, the expectation was for inflation to come lower, for the Fed probably to hike rates and maybe the economy was looking softer.

That's changed dramatically over the last 5 months with now the 10-year at 4.6%. And the whole curve has moved up quite a bit higher, most significantly at the short end where we've seen 2-year yields climb all the way to 4.3%. So on the one hand, that has been a sell off in fixed income, but on the other hand, yields are at a relatively attractive level. And current yield is a good baseline for total return of a fixed-income asset.

Phil: You hear you, me, Brent talk about balance in portfolios, think about fixed income as an asset class. If you're worried about the equity market, there are other asset classes. And when the 10-year Treasury was yielding 0.5% in 2020, it wasn't very viable from a yield perspective. Well, 4.6% is a lot higher than 0.5%. It doesn't mean we know where fixed income is going tomorrow. We don't. But what we do know is that there's yield today where there wasn't a few years ago.

Blake: Yeah, the 10-year Treasury yield is arguably the most important number in global finance. And as you said, it bottomed at about 0.5% in 2020, remained very subdued until the Fed started hiking interest rates in 2022. And really since then, a common question is "When are rates going to come back down to normal?"

Phil: Yeah. "When's my mortgage rate going to fall, right?"

Blake: Two different questions there—when are rates going to come down and when are they going to get back to normal.

As we continue to update this chart month after month after month and the x axis keeps getting longer, believe it not, soon we start showing 2027, that line is pretty flat between 4% to 4.5%, now 4.6%. It begs the question, "Is a 10-year Treasury in the fours or even the mid-fours, is that normal?" Not coming back all the way down to the twos and threes where it was during or even before the pandemic.

A lot of things go into the 10-year Treasury yield. A lot of it is growth and inflation. Growth is looking durable. Inflation is looking like it's going to be remaining elevated. Uncertainty is higher. Think about when yields were very low in the 2010s. A lot of that decade was spent recovering from the worst financial crisis in almost a century, but it was also a period where even though things were recovering, there wasn't a ton of global uncertainty. It was a time where there was a lot of stability, there was a lot of international trade. Companies were able to expand. There's a lot more uncertainty going on this decade.

And lastly and unfortunately, pretty much every developed market is running enormous fiscal budget deficits led by the United States. Of course, a higher fiscal deficit means more Treasury issuance, more Treasury issuance, more supply, more for the market to digest. So all of these forces are keeping that Treasury rate even higher. No one knows exactly where it will go, but the point is when are they going back to normal? Maybe this is the new normal.

Phil: That's right. And look, we're showing two vertical lines here where the Fed cut. The 10-year Treasury is yielding more than it was when the Fed started cutting in 2024. A reminder that if one is cheering for the Fed to cut, you want the Fed cutting for the right reasons.

And if they are cutting and there's still risk of inflation, longer rates may go up, not down, which is what we have seen of late. The Fed, Alan Greenspan, more on him in a moment, the late great Alan Greenspan, called this the Great Conundrum. The Fed controls the overnight rate. They do not control longer term rates, whether that's the 10-year Treasury or mortgage rates.

So let's look at a reminder in terms of equity markets. One, if you look at—this is going all the way back to 1990—and you can see annual returns in the bars of the S&P 500. First of all, you'll notice there's a lot more bars above than below, but you can have really severe drawdowns. Look at 2008, the Great Financial Crisis.

The diamonds here are the max drawdown, the intrayear drawdown in a given year. The average sell off is 15%. So in terms of your equity portfolio, every January 1—and I try to remind myself of this, by the way—on average, you should expect a 15% drawdown. This year so far, we've had 9% drawdown. That was this spring. Last year, we had a 19%.

Could we have another drawdown of 15%? Of course, we could. That's why you have to have balance in your portfolios, diversification in your portfolios, and stick to the plan. It's actually times of uncertainty that the plan matters the most, your financial plan, your investment policy statement, whatever it might be.

But just a reminder, this is a volatile asset class, right? Coming in and viewing equities as something that is not volatile, that is where mistakes are made. Drawdowns are the name of the game. That said though, I see some pretty big drawdowns here in which the market actually ended up up on the year—really notable.

Blake: Yeah, volatility sometimes feels like a dirty word, but if you're thinking of like just how much the series can move, look at the distance between a lot of these gold diamonds and then the top of the blue bar.

Phil: It's incredible. It's about having the right buckets. Equities are risk-on asset class. They are truly long term. And when we say long term, we mean 5 years or more. These are long-term asset classes. Just a reminder in terms of the S&P 500 for you all.

Another point, and we talked earlier about the 1990s and the tech bubble, the tech boom, the internet bubble, dot com, whatever you might call it. We also mentioned the late, great Alan Greenspan.

He gave a speech in December of 1996, famously, in which he referred to irrational exuberance in the equity markets. And he was pointing to what he was seeing accurately, which was some froth in the equity markets.

So let's look at the S&P 500. What was the actual path? Well, the issue is timing these things is the difficult part. Was he right that there was froth? Yes. Was he 3.5 years early? Yes. In fact, the S&P 500 rallied another 115% from that speech. And if you look at the low of the S&P in 2002, October 2002, it was 13% above the date he gave that speech. So it's not that Alan Greenspan was not seeing froth, it was that timing these things is the hard part, and as we showed before, we were seeing nowhere near the rise in Nasdaq as we saw in the late 1990s.

Reminder that even the best market watchers and some of the smartest people in the world, it's the timing that is difficult and saying, "Okay, I'm seeing some irrational exuberance." That could be right. You also could be 4 years early.

Blake: Yeah, what I hear you say all the time is you have to be right twice.

Phil: That's right.

Blake: And getting it right the first time is hard, getting it right both times is next to near impossible.

Phil: Yeah, so remember, financial plan, investment policy statement, have the proper allocation. That is what keeps us from making mistakes when there is a potential drawdown. That said, we could see volatility this year, but again, our price target of S&P 500 is 8,000. That's higher in 12 months than it is today.

So with that we’ll pause and take questions.

Amy: Hey. Before we jump into questions, just a reminder that we have several publications available throughout the month, and you can use the QR code on your screen to get signed up to have those sent directly to your inbox or visit FirstCitizens.com/Wealth to get signed up.

Thank you, guys, for going into markets in the economy. Phil, if you make one more '90s comment, we're going to have to change our intro music to something else.

Phil: It was a great decade, it was.

Amy: So we're in the middle of earnings season. Phil, what are you watching right now?

Phil: Yeah, it's still pretty early. Roughly 80 S&P 500 companies have reported to this point. Ninety percent are beating on the bottom line, which is above average. We're also seeing a beat on the revenue line, the top line, as well. There's a few things we've noticed, even though it is still early. One, there's not many misses, but those that do miss are being punished harshly. More harshly than average.

Why is that? Think—expectations are really high. It makes some sense that we are seeing misses punished more harshly. Clearly the bar has been raised, and companies have to hit that bar. It's still early. We're still waiting, including today, on the day we're recording for some hyperscaler results.

We still are very focused on the AI story and what are management teams saying in terms of CapEx spending expectations for the hyperscalers. And outside of the big tech companies, what are management teams saying in terms of potential benefits, productivity gains from AI? It's still too early to read too much into that, but really looking at the earnings season with 25% year-on-year growth, seeing 90% beat.

It's been a good earnings season so far, but clearly investors have really high expectations, and those who miss those expectations are being punished.

Amy: And speaking of expectations, Blake, there's a Fed meeting next week. What are you going to be watching?

Blake: Well, before the new leadership transition at the Fed, there was kind of this cottage industry of analysts who had like their Fed outlook. So you can put them all in room like—"My expectation is two cuts. My expectation is one. Mine's one hike."

It's not that simple anymore. And the Fed is not really positioning markets or these analysts to, sort of, even have that kind of guess. It's becoming more complicated where it's not just going to be about the rate hikes and the rate cuts. Chairman Warsh is bringing into conversation this other less talked about, more complicated tool of the Fed's balance sheet.

So there's a lot of debate on how affecting the balance sheet affects inflation and money and economic growth and financial markets. It's not as clear as the interest rates. And then second, there's not—we talked about this last month quite a bit—there's no more forward guidance. There's no more hand holding of communicating what the Fed's going to do before it happens. So it's only been a month, month and a half, so there's a lot still to learn about how he's going to be leading this institution.

But I'd say it's going be a lot of keeping an open mind. But the short answer is markets are not primed for any sort of move in July. But they are continuing to position and suss out potential hikes later this year.

Amy: And speaking of things becoming more complicated, it seems like everywhere you turn there's a geopolitical tension to navigate. What are your thoughts there?

Phil: Yeah. Look, geopolitical tension is elevated. It's been elevated for much of this year.

Blake: Much of this decade.

Phil: Much of this decade, and we've really had an additional flare up this year. And over the last decade, risk assets have actually done quite well, and they've done well year to date. Something we've shown a lot in the past is if you look at geopolitical events going all the way back to World War II, the market on average reacts, but usually regains its losses in about 6 weeks. That's on average. There's exceptions. But if you look at this year, we had a 9% drawdown with the war in Iran and the spike in crude oil prices. And here we are with a 9 to 10% gain year to date in the S&P 500. And other asset classes actually outperforming the S&P when you look at small cap and international, et cetera.

Volatility is likely to persist. Watch things like the price of crude oil. As Blake mentioned, it's on the rise. Supplies are tight. That is the transmission mechanism. That said, there's a lot happening in the global economy that is not tied to the price of crude oil, that might be more tied to the price of memory. That might be just as important.

So markets actually tend to look through geopolitical risk over the medium term even if it drives volatility in the short term. We don't think it's going anywhere. We are in a world that clearly has higher tensions. That is why, and I said this earlier and I'll say it again, that is why you have a plan.

Times like this, you stick to the plan. This is when you start swinging your portfolio around that can cause issues and permanent impairment. It is about understanding that, yes, equities are a risk-on asset class. Yes, fixed income is a viable asset class. And there's other ways to think about these things as well through, of course, diversification.

So stick to the plan, understand that yes, headline risk is a thing, but often the market looks through it more rapidly than one might expect.

Amy: Well, thank you both for answering questions, and thank you all for listening, and we hope you found this information helpful. And thank you for trusting us to bring you this information. That's something we never take for granted.

Authors

Brent Ciliano CFA | SVP, Chief Investment Officer

Capital Management Group | First Citizens Bank

8540 Colonnade Center Drive | Raleigh, NC 27615

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

Phillip Neuhart | SVP, Head of Market & Economic Research

Capital Management Group | First Citizens Bank

8540 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

8540 Colonnade Center Drive | Raleigh, NC 27615

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

Jack Pettit | AVP Research Analyst

Capital Management Group | First Citizens Bank

8540 Colonnade Center Drive | Raleigh, NC 27615

John.Pettit@FirstCitizens.com | 919-986-3667

Important Disclosures

This material is for informational purposes only and is not intended to be an offer, specific investment strategy, recommendation, or solicitation to purchase or sell any security or insurance product, and should not be construed as legal, tax, or accounting advice. Please consult with your legal or tax advisor regarding the particular facts and circumstances of your situation prior to making any financial decision. While we believe that the information presented is from reliable sources, we do not represent, warrant, or guarantee that it is accurate or complete.

Your investments in securities and insurance products are not insured by the FDIC or any other federal government agency and may lose value. They are not deposits or other obligations of, or guaranteed by, any bank or bank affiliate and are subject to investment risks, including possible loss of the principal amounts invested. Past performance does not guarantee future results. There is no guarantee that a strategy will achieve its objective.

About the Entities, Brands, Products and Services Offered

First Citizens Wealth® (FCW) is a registered trademark of First Citizens BancShares, Inc., a bank holding company. The following affiliates of First Citizens BancShares Inc. are the entities through which FCW products and services are offered. Brokerage products and services are offered through First Citizens Investor Services, Inc. (FCIS), a registered broker-dealer, Member FINRA and SIPC. Advisory services are offered through FCIS, First Citizens Asset Management, Inc. (FCAM), and SVB Wealth LLC (SVBW), all SEC registered investment advisers. Certain brokerage and advisory products and services may not be available from all investment professionals, in all jurisdictions, or to all investors. Insurance products are offered through FCIS, a licensed insurance agency. Banking, lending, trust products and services, and certain insurance products are offered by First-Citizens Bank & Trust Company, Member FDIC, and an Equal Housing Lender icon: sys-ehl, and First Citizens Delaware Trust Company.

All loans provided by First-Citizens Bank & Trust Company are subject to underwriting, credit, and collateral approval. Financing availability may vary by state. Restrictions may apply. All information contained herein is for informational purposes only and no guarantee is expressed or implied. Rates, terms, programs, and underwriting policies are subject to change without notice. This is not a commitment to lend. Terms and conditions apply. NMLSR ID 503941

For more information about FCIS, FCAM, or SVBW and its investment professionals, visit FirstCitizens.com/Wealth/Disclosures.