Making Sense: May Market Update

Making Sense

Market Update | May 2026

Recorded on May 27, 2026

Amy: Hi, I'm Amy Thomas. Today is May 27, 2026, and I want to welcome you to our monthly market update series. Today, Phil Neuhart and Blake Taylor, members of our market and economic research team, 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: Welcome, everyone. Thank you for joining us, and Blake, thank you for filling in for Brent today. What are we going to cover today? Well, one, of course the economy. Geopolitics remain in focus. We want to cover growth—what we're seeing in terms of economic growth in the US, interest rates, inflation. And we wanted to discuss housing, which we have not done in a few months.

From a market perspective, we have a stock market in the US at an all-time high. Corporate earnings have been incredibly strong. We want to dig in on valuations a bit, and then, of course, cover fixed income as well.

So with that Blake, why don't you jump in to the economy?

Blake: Yeah, well this chart here we've been showing in most of our presentations for the last few months, and that is for good reason. What this is showing is that for the last 12 weeks, basically no oil has transited through the Strait of Hormuz, and that's of course that narrow waterway between Iran and Oman, where about 20% of the world's oil would transit on any given day before the conflict.

So at the beginning of the war, we had professional analysts saying that it might take 10 to 14 days for oil flows to resume their normal transit through there. That got pushed back to a month. Now we're at 3 months, and it kind of begs the question of "Oil's still only at $100?" That is a very high number, but it's not as high as it might have been, given what some of these analysts were saying with the magnitude of the supply disruption.

So things are maybe looking in the right direction in terms of getting things back to normal here, but we just do flag this as a risk that even though the equity market has rebounded back to all-time highs and this conflict has dissipated from the headlines to some extent, this, for markets, probably is the most important metric here, and we really haven't seen any change there.

Phil: It still matters, and it's something that we're watching closely. This matters a lot for the global economy, as you'll discuss in a moment. We don't want to forget that there remains a real floor under the price of crude oil prices as long as this remains an issue.

Blake: Yeah. We've gotten a lot of questions from clients about, well, how are things different now compared to before because the US is not as reliant on oil from the Middle East. I think we start by emphasizing that oil is a global price. So no matter where we're getting our oil, eventually that global price is going to make its way into what US households and businesses are paying.

But just over the last decade or 20 years, the fraction of the oil that we import from the Middle East and from the Persian Gulf specifically has really plunged, and that's for mostly—the US Shale Revolution is producing a lighter type of oil that was replacing a lot of what we were importing from the Middle East. And US refineries rely more on a heavier crudes. We've been importing that from Canada for much of the last 10 to 15 years.

But even after adjusting for refining and changes in demand, what we're looking at in the righthand panel here is that the US never was hugely reliant on Middle East oil to begin with—at least compared to other countries.

So what we're showing here are the biggest oil consumers globally that are not of the OPEC cartel, and as you can see, China, India, Japan—three of the largest economies in Asia and in the world—they rely on Middle East oil to a tune of 30% to 80%.

So the US has never been as reliant on Middle East as some of these other countries, but just to go back to what we said at the beginning here, that oil is still a global price. So a lot of these are interesting, we wanted to put this in for so many of the questions we've gotten from clients, but the world is very different today, but oil remains globally priced.

Phil: So what's the impact on higher prices of crude oil and other products on growth? So here we're showing 2026 real GDP growth estimates from professional forecasters. This is consensus. And you can see that the expectation of growth has ticked down into the low twos, but really is nowhere near recessionary levels—kind of the 2% to 2.5% range.

One thing we pointed out previously that's worth discussing again is if you look at the consumer, which personal consumption is about 70% of US GDP, the consumer's percentage of their disposable income that they spend on gasoline and other refined products has fallen through the decades. Why is that? Engines are just more efficient. Homes are more efficient. We have hybrid cars. We have EVs. Does it matter? Does it hurt at the pump? It does, but it does not hurt at the pump as much as it would have in, say, 1980. We have seen a shift there.

From a recession probability perspective—over the next 12 months on the right side here—you can see recession probability is about, what, about a quarter, 28%. That has not skyrocketed during the war, and the reason is is that professionals know that yes, crude oil, it matters. Inflation matters. It's not the only variable, and there are a lot of variables that are driving this economy.

Blake: And some analysts that brought up their recession forecasts in the last couple months, some of them actually started bringing it back down.

Phil: Yeah, and look, we did not change our S&P 500 price target, for example, because we've kind of seen this story before. It matters, but it may not matter as much as some might think.

So let's talk about the impact on growth. So gross domestic product on the left side here, you can see that those estimates since March have fallen, but pretty moderately, again, that 2% to 2.5% range.

Personal consumption expenditures, that's consumer spending, they've also fallen, but still growing. Still growing in real terms, about 2%. Why have they moderated? Well, if gas prices are up, you should see some moderation in spending.

But what has improved has been nonresidential private fixed investment. So you say, "Well, what is that?" Well, that is the AI boom. We are seeing, of course, an explosion in data center investment. In fact, just over this last weekend, I saw a couple of data centers under construction in Georgia. So this is on the ground, it is happening, and we are seeing a real explosion in fixed investment driven by the artificial intelligence boom.

So what does that look like as you think about tech investment as a share of GDP? Well, this chart goes all the way back to the 1970s, and as you would expect—let's focus on the blue bars here for software.

Well, software wasn't—there wasn't much software in the 1970s, so as you would expect, this has trended up through time steadily. That is really a multidecade trend. You see one kind of blip up in the late 1990s into the early 2000s. Why was this? This was massive adoption of software. We went from people didn't have computers at home to they did, people didn't have computers on their desks to they did.

Let's look at information processing equipment, though, and this is interesting. It has also marched higher, as you would expect given the rise of technology in our economy for decades now, but look at those last few data points—really skyrocketing. This is AI.

So we are now above trend, as we like to say in economic and market analysis, that yes, that move higher you would expect, but we are now seeing it taking a much larger share of GDP than what we've seen in the past.

So what does this mean for the Fed, Blake?

Blake: Three months ago, markets were priced for the Fed to cut rates. What we had was a softening—but not collapsing, by any means—labor market. And most importantly, we had price trends that were headed back towards the 2% target. One of those two things has changed more than the other in the last 3 months, and that's the prices.

Phil: Inflation.

Blake: Inflation. The Fed is no longer able to really persuasively argue that inflation is completely under control the way that maybe they were beginning to argue at the beginning of the year. The result has been that, as you can see from this blue line down here at the bottom, before the Iran conflict the market was priced for one to two interest rate cuts over the next few quarters. Within 2 months—1 month ago by the end of April—that line had flattened out, and the market had removed its expectation for rate cuts, and instead it said we see the Fed on hold for the next several quarters.

What's new is in the last month the market has taken that up even higher, and now they're saying, "We expect the Fed not only to leave rates flat, but actually we see it as more likely than not that the Fed will raise rates over the next few quarters."

I would say that if you look at the difference between this gray line and this gold line—what this reflects is inflation is more of a risk than it was 3 months ago, and the labor market and the economy are not softening or weakening to a point where the Fed thinks that they need to support the demand side.

Phil: And Blake, something we hear a lot on the road is, "Well, we have a new Fed Chair coming in, Kevin Warsh. What does that change?" And something we remind folks of is, this is still a committee, right? And by the way, Kevin Warsh is a prior governor. He is going to focus on the dual mandate and so is the committee. So if the labor market is okay, certainly not great, but we're in kind of a low-hire, low-fire—unemployment rate in the fours, but inflation's reaccelerating—the Fed has to pay attention to that.

Blake: Absolutely. And what we're showing here is a very similar look on the same data, which is what's the outlook for the federal funds rate. That's the Fed's policy rate. And this is just looking through the end of this year, and something I would point out is back even 18 months ago—all the way until the beginning of the Iran conflict—what was priced in was the expectation the Fed would cut rates.

Now that that's being flipped to the other side, and we are now looking at tighter policy, that begs the question of "What other factors in the market and the economy rely on this that are now needing to be priced differently?"

One of the biggest things that Fed policy does is it alters financial conditions. It's not just about short-term borrowing rates, but it's about broad financial conditions in the entire system. And what's interesting is that a lot of times, at least in theory, when we would see this gray line, which is the expected amount of cuts, go from below the axis to above the axis, we would think that there's some kind of tightening that's involved.

And in fact, that's exactly why sometimes the Fed does want to increase rates, is to tighten those financial conditions—actually maybe rein in some of the exuberance in the equity market. So what I think is interesting here is we have seen some higher rates. In the short term, we've seen the 2-year rate move quite a bit higher, which is directly off of Fed expectations. Also further out the curve, we've seen a step higher in rates, but that has not punctured this equity market, which is what we're going to get into later.

Phil: That's right, and there are a lot of fundamentals driving that. So not to dwell too much on prices, we've talked a lot about crude oil, but when you look at inflation rates, whether it's the Consumer Price Index or the PCE deflator, which is the Fed's preferred measure, you can see that we've seen a real move higher.

It would be surprising if we didn't see this. We are all paying more at the pump and of course that is finding its way to inflation. But if you look at forecasts, which are the sort of light gold line, the dashed line here, expectation is that this is not long-lived.

The truth is no one knows, right, but consensus often, when you look at out years, finds its baseline at the Fed's target, which is 2%, which is, of course, that horizontal line in the chart. The short story is—right now, inflation's above target, and that has implications for the Fed.

So let's look at market pricing of inflation expectations here. Here, we're showing 1-year, 2-year and 5-year inflation swap rate. That's just a fancy way of saying, "What are markets pricing in terms of inflation?" What you can see is all moved higher, of course, with the breakout of war in the Middle East. They've come off their lows but still elevated. I mean, you still have the 1-year and the 2-year, I mean, and the 5-year as well above that 2% target.

So look, there is inflation in the system, and my instinct is that a lot of market participants are kind of positioned for inflation instead of being in the 1.5% to 2% range of the last cycle, they're looking at 2.5% to 3% range. If revenue and earnings growth remain strong and margins remain strong, the market can absorb this. Does that mean it's not a risk? No, of course it's a risk, and something we really have to pay attention to.

Blake: Last thing on inflation is that there are a million different ways to try to evaluate what the inflation rate is and what it's going to be. And what we're showing here is a statistical measure called the trimmed mean inflation rate. And this is just another way to try to isolate into the core measures to try to understand what's the underlying momentum behind inflation.

So what policymakers have done for decades is they've looked at a traditional measure of core inflation that strips out food and energy prices. That's received a lot of criticism because a lot of households spend a huge fraction of their income on energy and food.

Phil: Absolutely.

Blake: But what this measure does is instead of just isolating the same elements of the price basket of food and energy, instead every month it's looking at what are the outliers, what's really high maybe for some unusual reason, what's really low for some other anomaly, and then we're going to throw those out and just look at the middle.

And by that metric, inflation is really still not that far above the 2% target. This has been a metric that some people have argued is going to be getting some more attention as we move into a new leadership at the Fed.

So I think the point that I would make in showing this is, yes, we have all kinds of ways to measure inflation—private sector, public sector, conventional, nonconventional—and a lot of times it comes down to what index, what metric do you want to follow. We like to look at those market-based rates when we're looking forward, so we just wanted to put this here to make the point that the conversation around inflation is going to be continuing.

Phil: Absolutely.

Blake: What about the other side of the Fed's mandate, which is the labor market? We have been seeing some commentary in the last few months that the labor market is doing better, which I think is partially true. The rate of monthly job growth has improved somewhat, but it's still quite low.

But what we found over the last few weeks is some analysts put together an alternative labor market index that looks mostly at private-sector data, and instead of just looking at the level—how many jobs are there, what's the level of unemployment—instead it's looking more at the change and the momentum, the direction behind which way things are moving.

What we're showing here on the on Y axis is the number of standard deviations away from the norm, so how unusual is the positive or negative trend, and I think this makes quite a lot of sense that ever since the really fiery hot labor market of 2021 going into 2022, what we've seen is a steady decline in momentum through the labor market.

So not a skyrocketing in the unemployment rate, not massive amounts of job cuts, but just every month, things are a little bit less powerful. It's a little bit harder to find the right job. You don't have as much command with your employer on getting the pay raise that you want.

Phil: And we like to compare data to what we're hearing anecdotally. We have the benefit of meeting with a lot of clients throughout the country, and this softness is what we're hearing. It's not mass layoffs. It's not material decline like 2020 where we go off the chart, but we are sensing some softness in the labor market.

As I said earlier, at best it's an okay labor market. It's not booming, but it's not yet materially deteriorating, although it's clearly showing some signs of weakness.

Blake: We're sticking to this view of low hire, low fire, not very much churn. Employers are probably still wanting to hold onto their workers. No one wants to make any big changes, but also if you are out of a job, you're looking to make a change, the environment's not quite as robust.

Lastly, on the labor market, a point that we made last month that we really wanted to just repeat this time is that when we do hear about trends or the labor market maybe improving somewhat on the aggregate—which is what this gold line is here for wage growth—we want to look at it in terms of as many different cuts as possible.

And what we found last month was a new measure of small business wages that after adjusting for inflation shows that those workers have not really been pulling ahead as much as the aggregate in the last few years, and in recent months, actually their rate of inflation-adjusted wage growth has trended at or below zero.

So the point that we want to make here is that we don't want to just focus on the aggregate data. We care a lot about small businesses. Small businesses employ about half of workers in this country, even if they don't make up half the market cap. So this is where a lot of US households are sitting, and it really helps us understand why with a lot of headline economic statistics doing quite well and stock market at all-time highs, we're still hearing a lot of negative-sentiment reports.

Phil: Yeah, something that, not to go back to anecdotal again, but something that, speaking for myself at least, that I firmly am seeing not only in the data but in the marketplace is this concept of a K-shaped recovery. If you were a higher-end consumer, upper middle class, upper class, you own stocks, you own your home. Stock market's at an all-time high and home price appreciation we'll say is slowing, but your home is valued, depending on where you live, is probably at an all-time high as well. That is a positive wealth effect.

For those who don't own stocks, don't own their home or possibly rent, of course, well, they've seen negative wage growth, and that's why we're seeing things like credit card delinquencies rise. We are seeing some strain on the middle class and lower-income folks in America. So it's not that everyone's doing well, but higher income is certainly pulling us higher.

So let's turn to the housing market. Here, we're showing single-family house price growth year on year. You can see it's fallen to basically 0% to 1%, very low after an unbelievable pop in home price appreciation. It always is remarkable to me that you see in that period after the pandemic more home price appreciation than we saw during the housing boom before the Great Financial Crisis. So just put in perspective how dramatic it has been.

So now we're back to pretty low home price appreciation, which by the way, historically is not that rare, but it is what we are seeing. If you look at the quartile range, this is just 25% to 75%, you do see that some are negative, and this is the 20-city index. If you look through the cities, you will see cities that are down very slightly, but down year on year.

So what's going on here? There's a few things. One, the month's supply of homes, which just is a measure of inventory divided by sales, has risen. Now it has risen from the tightest we've seen in decades to a level that we sort of saw before the pandemic.

So in other words, there are more homes on the market. You are not going to see as much appreciation. But also affordability—something near and dear to your heart, Blake—remains a major challenge. We are seeing high mortgage rates, which I will show in a moment, but also again, negative inflation-adjusted wage growth and that price appreciation, it's in there. It's like inflation. When you have 20% home price appreciation, and now we're, okay, even if we were at 0%, it's like, well, that 20% still in there.

So this is the issue for new-time homebuyers, which is causing a market that's just still kind of locked up and remains a real challenge for the consumer, especially those who don't own their home.

Blake: Yeah, inflation rates coming back to normal does not mean that the price level has come back to normal. That's a one-time shift.

Phil: That's right, and it's very rare outside the Great Financial Crisis to see home prices on a sustained basis turn negative. What usually happens is that wages have to catch up, and that is where we are, which is a painful period.

To that point on affordability, here we are showing the 10-year Treasury yield and the 30-year fixed mortgage rate. Often we hear folks, and this is totally defensible, say, "I want the Fed to cut because I want mortgage rates to go down." The issue is, and we'll show this more in a moment—

Blake: I think I heard that from a Realtor a couple weeks ago.

Phil: Yeah. By the way, the Fed has cut. They've cut quite a bit in 2024 and 2025, but look at this chart, look at the 10-year Treasury and the 30-year mortgage. The 30-year mortgage is correlated with things like the 10-year Treasury and the 30-year Treasury, which by the way, and we'll show this in a moment, have not fallen.

So what we're seeing is mortgage rates have kind of flattened out. Now, they've flattened out at rates that, and you could see this even before the financial crisis, at levels that are honestly pretty normal.

If anyone in your life bought a home in the 1980s, these mortgage rates look really, really attractive. The issue is we all have recency bias, and when your neighbor has a 2.5% mortgage, it just really hurts to go so much above that, to be at 6%, for example. But our point—and we feel this way on longer-term rates—is if you're waiting for rates to fall, you might be waiting a while, and we have seen this in recent years, basically a sideways move in rates.

Blake: The last interesting thing we want to point out on the housing market is that half of mortgages still have a rate below 4%—even though what you just showed is that the prevailing new mortgage rate is between 6% and 7%. So what happened here? Back during the pandemic when mortgage rates reached historic lows, an enormous fraction of households either bought a home or refinanced the one that they already had.

Those are now locked in, and anecdotally and in the data, we're seeing families and households not wanting to move just because they can't get out of their mortgage rates. So what we have is over about 20% are still below 3%, which is only something that, as you can see, became a thing in 2020 and 2021 when rates were pushed so low. But a full 30% is still in the 3% to 4% range.

Another interesting point is that this is only for homes that have a mortgage. Forty percent of homes actually don't have a mortgage. That number has crept up quite a bit—38% in 2020 and 33% in 2010. So just a much smaller share of homes in this country are affected by changes in the mortgage rate.

Phil: And some of that's our demographics are changing, we have an aging population, baby boomers are moving into retirement and making sure that they paid off their house before they were in retirement, but also they were able, you know, a decade ago or even less to refi into a very low mortgage and try to pay that off.

So a housing market that I wouldn't describe as healthy. Supply has increased, but you still have a lot of folks that are just not going to move out of their home with rates this low.

So Blake, what about markets? What are we seeing in the S&P 500?

Blake: Well, this chart shows that the S&P 500's back. If we look at the bottom panel of this, this is just making, printing a gold line every single time that the S&P 500 hits a new all-time high.

So as you can see, we took a little break in the March and April period, and then as soon as that ceasefire announcement was made and—as you will get into importantly, when we started to see corporate earnings growth really take off—the S&P 500 has notched new all-time highs seemingly as often as it does, and almost every other day seems to be a new all-time high.

So just after yesterday, S&P 500 was above 7,500, climbing to new heights, and we're going to get into that a lot more.

Phil: That's right.

Blake: And to make that point even further about that ceasefire announcement and to really tee up what you're going to get into, Phil, we did see in the first few weeks of the Iran conflict, every single time that the oil price went up by 10%, the S&P 500 declined by about 1%—so about a negative 0.1 relationship.

That broke in early April when the oil price did not start to decline and go back to where it was, but the S&P 500 moved on. What that appeared like at the time was that the market just doesn't really care about conflict anymore, doesn't care about the oil price.

That is not the full story at all, and what actually happened was yes—maybe the market did move on a little bit, maybe it realized not as much of these companies are exposed to the oil price or to this conflict—but something much more important happened.

Phil: Yeah, and that is earnings season. It helps the market to move on when earnings season reminds you that not as many companies driving earnings are all that exposed to energy prices. So here, what are we showing? We're showing the contribution to S&P 500 earnings growth for this year, for 2026. If you look at the top chip manufacturers and mega-cap tech, sort of the top nine, over half of earnings growth is being contributed by those companies. The rest, about 47%, are the remainder S&P 500 companies.

So one, you'd say, "Well, earnings are top heavy." In a moment, I'll talk about the fact that we are seeing good results outside of that, but it's just a reminder that what is pushing this market higher are things like the artificial intelligence trend. How does artificial intelligence not just help those hyperscalers but companies that are smaller? Why are small-cap names outperforming year to date? There is a story beyond the Middle East, and a lot of that has to do with the AI boom.

So let's put some numbers behind this. If you look at first quarter earnings growth estimated, it was 28%. That is remarkable and well-above expectations. Now you have calendar year 2026 estimated growth of 22%.

Let's put this in perspective. Average earnings growth since 1950 is 7.6%. So again, price is up, but earnings are up, which does make this an interesting period. We'll talk about valuation in a moment.

Earnings expectations are above the price appreciation we've seen so far this year. Some context, as of late last year, the 2026 estimate was 14%, so now it's 22%. So just in, what, 5 months, we have seen an 8% rise in earnings expectations. So what about—we just mentioned that these big companies are pulling earnings higher, that's 100% true, but what about the other names?

So if you look at first quarter earnings growth for the S&P 493, so everything outside what we call the Magnificent Seven, that was 17.3%. That's the highest it has been since fourth quarter of 2021—and by the way, the 2026 estimate for this 493 is about 18% earnings growth.

Again, the biggest names are pulling us higher, but when you're doing 17% in a quarter, 18% in a year, an average is 7.6%—that's something that we have to pay attention to and acknowledge that it's not just the biggest names, which by the way, was something you could have said for a couple years there. I just don't think we can say that anymore.

On the right side, margins, all-time high, continue to move higher, margins cannot continue to expand at this rate. By the way, I was saying that a year ago.

Blake: Is that before the chart went vertical?

Phil: Right when it started to go vertical. So we have something where you'd say, "Well this isn't sustainable." Sure, for sure. We will not have 20% margins for the entire S&P 500 in perpetuity, but the market has to price what it is seeing, and what is in the price right now is earnings growth and margin expansion.

Coming back to your point about what we saw at the beginning of the year, a big thing that we talked about in our annual outlook was about valuation. The market was expensive, and there was no way around that.

What we've seen over just the last few months is that, of course, during the big market sell-off during the peak of the Iran conflict, the price came down and that brought our price-to-earnings multiple down, of course.

However, even though the market is back to all-time highs, well above where we were actually on February 28th, the price-to-earnings ratio is below where we were. And this is just tying up everything that you just said about comparison between a rise in the price and then a blockbuster earnings season with increasingly optimistic projections for the rest of the year, is that looking to the next 12 months, the stock market is not as expensive as it was 3 months ago despite being at all-time highs.

Phil: Yeah, so if valuation, which by the way is not a great predictor of return, but valuation is the only thing you care about. What's the price you pay for a dollar of earnings? If you liked the market on December 31 coming into this year, you technically should like it more today. That's hard to believe with the market all-time high, but it's because earnings have been so strong.

So let's look at valuation price-to-forward earnings of the top 10, the biggest names, and the other 490. We often hear the market's expensive. That is factually true, right? If you have a stock market trading anywhere around 20 times, it is high versus average.

Couple things I'd point out. First, the market rarely trades at average. In fact, as you can see here, it can be cheap for an entire decade, it can be expensive for an entire decade. So one, try not to get too caught up in price, but also I would point out that when you look at the top 10, yes, they are really expensive. The other 490 are not cheap but are not nearly as expensive versus those largest names.

Now, by the way, a lot of those largest names have unbelievable pricing power, fortress balance sheets, et cetera. There's a reason they are expensive, but we do have to remember that not everything in the S&P 500 is expensive.

I think—and even if you look at small caps, et cetera, some of the performance this year is the marketplace recognizing that—that it is not just 10 companies that matter within the stock market.

So let's look at our price target. As a reminder, our price target is for the S&P 500. It's next 12 months. It is not year-end. That is by design because year-end price targets, both of us used to work on what we call the sell side, the problem with the year-end price target is you get to the back half of the year, it's basically meaningless. You're making a 5-month or 4-month or 3-month forecast.

So our price target base case is now 8,000. That number was 7,300 last time we updated this. That is a big jump, and I want to make something clear when we're working our file, working on our price target. This is fully due to upward earnings revisions. As I mentioned, the 2026 earnings revision moving much higher, 2027, those numbers we've seen move higher. This is driven by earnings.

This is not us saying the multiple's going to move higher. In fact, our base case assumes no downward revision over the next 12 months to expected earnings. Only 9.5% earnings growth in months 13 to 24, which by the way is above average, but well below with what we've been doing and actually slight multiple contraction. That gets us to 8,000, that's up about 6.4%.

If you're more bullish, you expect outperformance, you're talking 16% upside. And then of course the bear case, which there is always a bear case, is down over 20%. By the way, when we look at bear, base, bull, we are not saying the extreme bear, the extreme bull. As we know through history, we can see moves stronger than these. What we're saying is within reasonable expectations, where are we?

So again, the talking point here is, yes, we have upside to our base case, our numbers moved higher, that has been fully due to earnings expectations, not due to saying the market's going to be more expensive on price-to-earnings ratio.

Blake: And I see something in here that you've kept in is a little bit of asymmetry between the bear and the bull.

Phil: Yeah, so and this is something we've had for a while. When the market's at all-time highs, our analysis but also anecdotally, we like to have more downside to the bear case than upside to the bull because it acknowledges that the market isn't cheap, and of course we can see a drawdown.

We had a 9% drawdown this year. We had a 19% drawdown last year during tariffs. Drawdowns do happen. There's segments of the market that are quite expensive. Seeing some chop during the summer is normal. This is something that you all have heard Brent, Blake and I talk about. Volumes fall, especially late in the summer, and sometimes we can see some choppiness.

That is not about fundamentals, though. The fundamentals are telling us modest upside, high single-digit to mid single-digit upside from here.

Blake: Yields are higher. Three months ago, we saw Treasury rates about 4/10 to 6/10 of a percentage point lower than where they are now. A lot of that has been due to movement in the short end, higher inflation risk, those Fed rate cuts coming out of the forecast.

However, looking further out on the curve 10 and 30 years, those rates have gone up 4/10 to 5/10 as well, and that doesn't have as much to do with near-term Fed policy. So we'll get into that in the next slide a little bit, but we wanted to lay the groundwork here and just make the point that rates are higher, and from an investment perspective, a lot of times when we see those yields higher, what we want to emphasize to long-term investors is these are attractive entry points.

Phil: Yes.

Blake: Looking at global 30-year sovereign yields, we are at a remarkable point. I'll actually start with the Japan yield, which at 4% on their 30-year sovereign bond is actually the highest that it's been since it was started to be recorded in 1999.

The rest of these developed-market economies are seeing their 30-year government bond at the highest yields in 15 to 20 years. So what is driving this?

As we just said on the previous slide, it's not just central bank policy. It's higher inflation, higher uncertainty and higher risk around inflation, where investors are demanding to be compensated this far out on the curve for holding that bond for so long. What a lot of fixed income analysts refer to this as is a higher-term premium.

It's not just due to factors that we can see happening in today. It is about what's driving much further out, what's driving risks and what are investors able to expect or anticipate and when things are much more uncertain and when governments are issuing huge amounts of debt as they have been well before 2020, but especially since 2020, then that additional supply is something that investors are having to contend with.

Phil: Our clients and investors are very focused on the fiscal situation in the US, but that remains a global story—Japan kind of being an easy example for you all there. Volatility and inflation, lots of issuance and some uncertainty around the fiscal situation of large developed nations has to increase that term premium and push yields higher.

Blake: The 10-year Treasury has remained remarkably flat over the last few years. Yes, ups and downs, but if we can look back over the last decade, look at how look at how stable the 10-year Treasury has been and around that 4.2% channel with a little bit of give and take.

And I think that what part of why we really like continuing to show this chart is to make the point that when we talk about things returning to normal—think about all the times we've emphasized returning to normal in the back half of this decade. The labor market getting back to normal, inflation making its way back to 2%.

Something that we often hear people ask is, "Well, when are rates going to get back to normal?" Well, Phil, what is normal? Normal we don't think is that period from 2010 through 2021 when rates were close to 0%.

Phil: Four and a half percent historically, if we widen out this chart, is not high. It's actually fairly normal, which "What is normal?" is really a philosophical question. But what would bring rates lower might be things we don't want. It would likely be a very severe recession, et cetera. What we've been telling clients really for years now is if you're waiting for longer-term rates to move lower to run your business, you might be waiting a while.

That we've seen a return to normality—money was very cheap for a decade after the financial crisis, by the way, because we had a broken economy. This is normal, and I think something our clients have to accept and so do we.

So let's talk about the S&P 500 and the fact that we know we have an expensive market, and there's a lot of comparisons to the 1990s. I know I'm very guilty of that, talk about the 1990s a lot. Why is this? We're in a tech boom, and it reminds us all of the mid- to late 1990s.

So something that we want to point out, though, is time is an important variable here, and how long these things can run is quite uncertain, and we try to have the ability to know that we certainly cannot predict that. All we can do is look at the fundamentals. So in the 1990s, Chair Greenspan—a great FOMC chairman who of course is very respected and was a major figure in markets and the economy for decades—he gave a speech called the Irrational Exuberance speech, and this is when he noticed that there was a lot of irrational exuberance, and there have been books now titled "Irrational Exuberance." This is a very popular phrase, particularly in the equity market.

He gave that speech in December of 1996, called the "tech market bubble" in December 1996, I put up quote marks. The market did not peak until 2000, and by the way, if you look at its low in October of 2002—which any of you who were investors during that period like me, this was a very painful 2 years—the S&P 500 never dipped below the level it was when Alan Greenspan gave that speech.

Blake: So people who bought the market on the day of his speech fared better than those who sold.

Phil: Yes, and those who sold, by the way, as anyone who's ever shorted the market, they had a very painful ride over the next several years. So it's just a reminder that it is time in the markets that pays over the long term. It is not being overly concentrated, right? This is a different story if you only own the NASDAQ, but that's not what we recommend clients do. We recommend clients own the market in the US and globally.

If you had diversified, even diversified large caps, you were okay in the long run, but as a reminder, stocks are a long-term asset class. These are not short-term investments. If you're investing for a year, 2 years, 6 months, stocks may not be the place to be. That's why we have fixed income, and we do have yield there. With that, we'll pause for questions.

Amy: Hey, before we jump into questions, I just want to remind you that we have several publications available throughout the month. You can use the QR code on the screen to get signed up or visit FirstCitizens.com/MarketOutlook to get signed up. You can also follow us on Apple Podcasts, Spotify and YouTube Music.

Well, thank you both for taking the time to go through what's happening in markets and the economy. Phil, one thing I want to touch on again is thinking about the commodity market and how the US is independent and creating a lot of its own oil. Why are gas prices still so high?

Phil: Yeah, so you often hear—and this is something Blake touched on, but just to reemphasize—you hear that the US is oil independent or that we export crude oil. That is true. The part that those folks don't say is that we also import millions of barrels of crude oil. The reason is no one consumes crude oil, raw crude. No one does. What you consume is refined product—gasoline, jet fuel, heating fuel, et cetera.

And what with the Shale Revolution, fracking is our new technologies in the US, we now produce a whole lot more oil than we did when we built our refineries. And what we produce is called light sweet crude. That is the vast majority of what we produce now. Well, the majority of our refining capacity is heavy crude. Why is that? Those refineries were built decades ago when what we were producing and importing was heavy crude. So what we are now doing is—yes, we are still importing crude oil to be able to refine it. It is a global market. We're importing a lot from Canada, as Blake mentioned.

Yes, WTI stands for West Texas Intermediate. But the idea that we're completely energy independent really is mistaken. It's just not true. We import a lot of crude oil, and the reason is we have to go to refine it. And when you have tight supplies in a global market, it's going to push prices up, and that's what we've seen.

I will point out that there is a spread. Brent crude, which is the global standard, is above WTI today. Why is that? That is because of some of the bifurcation that we've shown on slide five between the US dependency on Middle East crude and other nations. That doesn't mean that we aren't exposed. We are exposed.

Blake: I think it's a good opportunity to think even beyond oil and gasoline. A lot of what is coming out of the Middle East and a lot of what's disrupted are other chemicals and raw commodities, a lot of things used for fertilizer, for example. So the longer that this conflict drags on, the longer that commodities are not moving where they're supposed to, when they're supposed to, for the price that they're supposed to, then the more we're going to see input prices rise, and that's going to feed through our price system, particularly in food.

Amy: Well, Blake, you mentioned that the labor market and our small business owners are very important to us because they do make up about half of the US employment status. What are you thinking about when, and what are you saying to clients when you think about the narrative shift within the Fed around interest rates and how that might impact small business owners?

Blake: Small businesses are just more exposed, really, to all the ebbs and flows and the shocks of the economy, I would think. So like prices, for example. A big company is able to negotiate a big contract with a supplier domestically or globally in Asia.

So when tariffs hit and now that supplier has a 15% to 25% price increase, the big business is able to come to them and say, "We want to negotiate that down." If a small business comes and says, "We want to negotiate it down," then they have a lot less influence to do so.

You asked about the Fed. A lot of small businesses tend to be more rate-dependent than big business, especially today's top 10 big companies. So when changes in Fed funds happen and shorter-term interest rates, then floating-rate debt tends to become more expensive for them. A lot of small businesses are benchmarked to the 10-year rate, and we've seen those rates climbing higher.

So debt is more common in smaller businesses. It's part of what we were talking about during our equity market presentation is that these big companies have had so much free cash flow that they really until a few weeks ago haven't been issuing much debt at all. But I think the point that I would make is that the small businesses do tend to be more, they do follow more of the ebbs and flows and the shocks, I'd say.

Phil: Absolutely. And the only thing I would add is the largest businesses also—in many cases when you look at the top 10—have incredible pricing power and smaller businesses tend to be what we call price takers. They're in a marketplace and the invisible hand determines price. Well, if you are a dominant player in a global market, which many of these largest companies are, they have pricing power.

So let's say they're exposed to inflation—which they might be less so, but let's say they are—they can just raise prices. And that is a big differentiator as well.

Blake: And I think that's a concern of mine is that as you mentioned the concern for small business a little bit, and with now looking at rate hikes as looking more likely than rate cuts as per market pricing, it's those smaller businesses that are going to feel that the most.

So if inflation is high and we want to try to bring price growth lower but what we're facing is higher commodity prices, oil price shocks—I don't think we mentioned this, but the price of computer chips and memory RAM is estimated to be somewhere like north of 150% to 200%. So those are not things that you're going to be able to rein in inflation in those categories by tightening conditions for small businesses. But these are the tools that we have try to address the inflation issue, so that's what we're going to use.

Amy: And Blake, speaking of tech and earnings, Phil, on the road I'm sure you're getting the question around with earnings going through the roof and markets continuously hitting new all-time highs, what are you saying to clients who are asking about maybe money on the sidelines or maybe pausing on decisions? What are you saying to them?

Phil: Yeah, I think it really is a reminder when you've seen markets move like they have really since the low in 2022 with a couple pauses last year and this year, it's a reminder of the importance of having a plan. So if you're an individual, a financial plan. If you're an institution, an investment policy statement, and sticking to that plan instead of being in a situation where, "Well, I have money on the sidelines. What do I do now?" Have the plan to start.

One thing we always point out—and I did a few moments ago—is that stocks, equities, they're certainly a long-term asset, right? They are volatile. Seeing volatility in stocks is the norm, not the exception, but they do generate return, as we've seen through the decades over the long term.

For shorter-term assets, there is intermediate and short-term fixed income, which is yielding and that is a real opportunity, and then of course there's the shortest, which is cash. So work with your First Citizens partners to understand the various buckets and how much you should have there, but stick to the plan.

This has been a year, another reminder of that, that at the depths of the war in the Middle East, the market was down 9%. There was some panic forming in the marketplace, and really the best thing to do during that moment was to stick to the plan. So if there's one thing I would take away from today, it is to remember that volatility can be short-lived even if it is inevitable.

Amy: Well, thank you both for answering questions and again for going through markets and the economy with us. We want to thank you all for listening and for trusting us to bring you this information. That's something that we never take for granted, and we look forward to seeing you again next month.

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

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