CIO Tom Galvin on Bloomberg's "The Close"
Higher for Longer: A Deep Dive into CNR’s Non-Consensus Outlook and Investment Implications
Summary of September 29 Market Update Webinar
INFLATION, THE BEAR MARKET & AN ECONOMY IN FLUX
An increased risk of a recession, higher interest rates, geopolitical conflict, high inflation and slower economic growth. All of these factors impacted the investment strategy in our September 2022 market update. The biggest change in the update was that CNR's estimate of the likelihood of recession has risen to 60%, up 10% from our August recession forecast of 50%.
The U.S. Federal Reserve has made it clear that they will continue to raise the federal funds rate to combat inflation. They have also acknowledged that their actions are likely to cause more pain in the economy, said Garrett D'Alessandro, CEO of City National Rochdale.
Despite continued strength in the jobs market, wage gains and strong household net worth, higher interest rates, high inflation and a volatile stock market have potentially created a "negative feedback loop that leads to lower returns," said D'Alessandro. CNR's investment managers expect markets to remain highly volatile, and further downside is possible until investors have better clarity on both the path of inflation and Fed tightening, as well as prospects for economic and corporate profit growth.
In response to a variety of global economic and geopolitical pressures, CNR's strategy is to continue to avoid exposure to European and Asian equities, and to focus instead on high quality U.S. companies with strong balance sheets. In addition, CNR is focusing on investment-grade corporate and municipal bonds, where yields are now attractive, and some high yield corporate and municipal bonds that offer attractive yields despite higher levels of volatility.
THE RISK OF RECESSION
Despite strong fundamentals, the risk of a recession has increased, and uncertainty continues to roil the markets. CNR's economic outlook is more conservative than some other economists and financial analysts because of the negative feedback loop that continues to drive the Fed to raise rates and to impact business and consumer sentiment, explained D'Alessandro.
CNR continues to think that inflation and the Fed's response will determine the direction of travel for markets ahead. Until a pattern of lower inflation readings is established, equities will likely have a hard time mounting a sustainable rebound, and bonds could remain under pressure.
UNCERTAINTIES DRIVING INFLATION & RECESSION RISKS
CNR's SpeedometersSM, forward-looking indicators of numerous economic and financial market metrics, continue to weaken reflecting a slow growth to mild recessionary outlook. Among the more negative indicators this month is monetary policy, with the Fed taking an even more aggressive stance in its attempts to rein in inflation. The impact of higher borrowing costs is already evident in the housing market, which is the most interest rate sector of the economy.
More positively, the job market remains historically tight and continues to keep wage gains high, which has provided the disposable income growth for households to continue spending despite higher inflation. However, CNR believes that wages are ultimately the key to the inflation outlook, and that the Fed will have to continue tightening until it slows labor demand. The prospect of even tighter monetary policy in the near-term points to the potential for a sharper slowdown in economic and corporate profit growth than is currently factored into market expectations.
It could take years to get inflation down to the Fed's target rate of 2%, said Paul Single, managing director, senior economist and senior portfolio manager for City National Rochdale. While inflation trended down recently, that was primarily because of lower gas prices, which tend to move more quickly due to supply and demand, said Single. This slide, based on research by the Bureau of Labor Statistics, compares the Consumer Price Index (CPI) and the Atlanta Federal Reserve's Sticky-Price CPI, which includes about 70% of the CPI index. The "sticky" elements, such as food and energy costs, as well as rent, tend to move more slowly and continue to trend upward, said Single.
CONSUMPTION IS MAJOR FORCE BEHIND US ECONOMY
Consumption is the biggest part of the U.S. economy, representing about 70% of GDP. However, a lack of recent stimulus checks means this sector of the economy is rapidly changing.
"Although the Fed's actions haven't had much of an impact on inflation, they are starting to impact behavior, which will help out quite a bit," said Single. "A lot of this has to do with the fact that people are no longer getting stimulus checks and inflation has moved up, so people have less disposable income."
HOUSING DEMAND AFFECTED BY INCREASED INTEREST RATES
Housing is one part of the economy where the Fed does have a lot of control, said Single. Housing inflation is at the highest level in about 40 years, according to the Bureau of Labor Statistics.
The Fed's actions that have led to higher interest rates are beginning to slow down demand in many housing markets, but CNR's experts do not expect home prices to fall on an annual basis, due to the continued supply shortage. Instead, home appreciation is likely to return to a more normal rate of 5% annually and mortgage rates are also expected to be closer to the average of 5.5%.
CNR is below consensus expectations on GDP and corporate earnings growth, and above consensus expectations on interest rates.
"We're more conservative than the majority of people in all these categories," said D'Alessandro. "We've been through many of these cycles, and we think our prudent and conservative views have served us well."
HOW LONG WILL THE BEAR MARKET CONTINUE?
To place today's bear market in historical context, we compared the average decline during bear markets, the average length of the decline and the average time to recover. On average, for example, the S&P 500 declines about 31% in a bear market, which means the current bear market decline of about 21% year-to-date is still well below average.
CNR's researchers anticipate modest equity returns in 2023. While valuations adjusted over the first half of the year, the earnings adjustment process has a way to go. CNR thinks that consensus expectations remain too optimistic given elevated uncertainty around the outlook and rising recession risk.
INVESTMENT-GRADE & CORPORATE MUNICIPAL BONDS
For the first time in many years, investment-grade corporate and municipal bonds are offering attractive returns, said D'Alessandro. As a result, CNR is recommending more allocation going into fixed income than in the past.
Higher yields are a welcome change, but price volatility will remain. Rising recessionary probability will hurt credit based investments, however long-term yield opportunities drive CNR's allocation recommendations. There continues to be volatility in the bond markets, but investors who buy and hold bonds to maturity will get their yield, which makes this an attractive asset class, said D'Alessandro.
We continue to be proactive in making defensive decisions for their clients as risk to the outlook rise and is ready with potential further actions for some investors if necessary. In the meanwhile, CNR's investment managers remain focused on owning high quality companies with strong balance sheets, strong management and good long-term projections.
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Important Disclosures
The information presented does not involve the rendering of personalized investment, financial, legal, or tax advice. This presentation is not an offer to buy or sell, or a solicitation of any offer to buy or sell any of the securities mentioned herein.
Certain statements contained herein may constitute projections, forecasts and other forward looking statements, which do not reflect actual results and are based primarily upon a hypothetical set of assumptions applied to certain historical financial information. Certain information has been provided by third-party sources and, although believed to be reliable, it has not been independently verified and its accuracy or completeness cannot be guaranteed.
Any opinions, projections, forecasts, and forward-looking statements presented herein are valid as on the date of this document and are subject to change. Alternative investments are speculative, may entail substantial risks, offer limited or no liquidity and may not be suitable for all investors.
Private investments often engage in leveraging and other speculative investment practices that may increase the risk of investment loss, can be highly illiquid, are not required to provide periodic pricing or valuation information to investors, and may involve complex tax structures and delays in distributing important tax information.
As with any investment strategy, there is no guarantee that investment objectives will be met and investors may lose money.
Diversification may not protect against market loss or risk.
All investing is subject to risk, including the possible loss of the money you invest.
This information is provided pursuant to a specific request and is for informational purposes only. None of the material, nor its content, nor any copy of it, may be altered in any way, transmitted to, copied, or distributed to any other party, without the prior express written permission of City National Rochdale. Analytical results have many inherent limitations and no representation is made that any investor will or is likely to achieve results similar to those shown. Changes in the assumptions used may have a material impact on the derived performance presented. The views expressed are also subject to change based on market and other conditions.
The 4P analysis is a proprietary framework for global equity allocation. Country rankings are derived from a subjective metrics system that combines the economic data for such countries with other factors including fiscal policies, demographics, innovative growth and corporate growth. These rankings are subjective and may be derived from data that contain inherent limitations.
City National Rochdale Proprietary Quality Ranking is the weighted average sum of securities held in the strategy versus the S&P 500 at the sector level using the below footnoted formula.
City National Rochdale Proprietary Quality Ranking formula: 40% Dupont Quality (return on equity adjusted by debt levels), 15% Earnings Stability (volatility of earnings), 15% Revenue Stability (volatility of revenue), 15% Cash Earnings Quality (cash flow vs. net income of company) 15% Balance Sheet Quality (fundamental strength of balance sheet). *Source: City National Rochdale proprietary ranking system utilizing MSCI and FactSet data. **Rank is a percentile ranking approach whereby 100 is the highest possible score and 1 is the lowest. The City National Rochdale Core compares the weighted average holdings of the strategy to the companies in the S&P 500 on a sector basis. As of June, 2022.
The information presented is for illustrative purposes only based on various assumptions. No representation or warranty is made as to the reasonableness of the assumptions made or that all assumptions used have been stated or fully considered. There are no representation made that any investor will or is likely to profit similar to those shown. This information is not intended to be used or construed as tax advice, and cannot be used by the recipient for the purpose of avoiding penalties and/or any tax liabilities that may be imposed under local tax codes in the applicable jurisdictions.
The material contains forward or backward -looking statement regarding intent, beliefs regarding current or past expectations. Readers are cautioned that such forward-looking statements are not a guarantee of future performance, involve risks and uncertainties, and actual results may differ materially from those statements as a result of various factors. The views expressed are subject to change based on market and other conditions. There can be no assurance that an investor will achieve profits or avoid incurring losses.
The information presented does not involve the rendering of personalized investment, financial, legal, or tax advice. This presentation is not an offer to buy or sell, or a solicitation of any offer to buy or sell any of the securities mentioned herein.
Certain statements contained herein may constitute projections, forecasts and other forward looking statements, which do not reflect actual results and are based primarily upon a hypothetical set of assumptions applied to certain historical financial information. Certain information has been provided by third-party sources and, although believed to be reliable, it has not been independently verified and its accuracy or completeness cannot be guaranteed.
Any opinions, projections, forecasts, and forward-looking statements presented herein are valid as on the date of this document and are subject to change.
Alternative investments are speculative, may entail substantial risks, offer limited or no liquidity and may not be suitable for all investors.
Private investments often engage in leveraging and other speculative investment practices that may increase the risk of investment loss, can be highly illiquid, are not required to provide periodic pricing or valuation information to investors, and may involve complex tax structures and delays in distributing important tax information.
As with any investment strategy, there is no guarantee that investment objectives will be met and investors may lose money. Diversification may not protect against market loss or risk.
All investing is subject to risk, including the possible loss of the money you invest.
Indices are unmanaged and one cannot invest directly in an index. Index returns do not reflect a deduction for fees or expenses. Past performance is no guarantee of future performance.
This material is available to advisory and sub-advised clients, as well as financial professionals working with City National Rochdale, a registered investment advisor and a wholly-owned subsidiary of City National Bank.
Indices are unmanaged and one cannot invest directly in an index. Index returns do not reflect a deduction for fees or expenses.
S&P 500 Index: The S&P 500 Index, or Standard & Poor’s 500 Index, is a market-capitalization-weighted index of 500 leading publicly traded companies in the U.S. It is not an exact list of the top 500 U.S. companies by market cap because there are other criteria that the index includes.
Muni Bond: A municipal bond is a debt security issued by a state, municipality or county to finance its capital expenditures, including the construction of highways, bridges or schools. These bonds can be thought of as loans that investors make to local governments.
Bloomberg Barclays U.S. Corporate High Yield Bond Index: measures the USD denominated, high-yield, fixed-rate corporate bond market.
Dow Jones Select Dividend Index: The Dow Jones U.S. Select Dividend Index looks to target 100 dividend-paying stocks screened for factors that include the dividend growth rate, the dividend payout ratio and the trading volume. The components are then weighted by the dividend yield.
The Intercontinental Exchange (ICE): The Intercontinental Exchange (ICE) is an American company that owns and operates financial and commodity marketplaces and exchanges.
The Bloomberg Aggregate Bond Index: "the Agg" is a broad-based fixed-income index used by bond traders and the managers of mutual funds and exchange- traded funds (ETFs) as a benchmark to measure their relative performance.
U.S. Treasury Yield Curve: refers to a line chart that depicts the yields of short-term Treasury bills compared to the yields of long-term Treasury notes and bonds.
Consumer Price Index (CPI): is a measure that examines the weighted average of prices of a basket of consumer goods and services, such as transportation, food, and medical care.
Bloomberg Barclays US Aggregate Bond Index: The Bloomberg Aggregate Bond Index or "the Agg" is a broad-based fixed-income index used by bond traders and the managers of mutual funds and exchange-traded funds (ETFs) as a benchmark to measure their relative performance.
MSCI Emerging Asia PE: The MSCI Emerging Markets Index is a selection of stocks that is designed to track the financial performance of key companies in fast- growing nations. It is one of a number of indexes created by MSCI Inc., formerly Morgan Stanley Capital International.
Global Equity Markets: a global market in which shares of companies are issued and traded, either through exchanges or over-the-counter markets.
The Commodity Research Bureau (CRB) Index acts as a representative indicator of today's global commodity markets. It measures the aggregated price direction of various commodity sectors. This commodity index comprises a basket of 19 commodities, with 39% allocated to energy contracts, 41% to agriculture, 7% to precious metals, and 13% to industrial metals. The CRB is designed to isolate and reveal the directional movement of prices in overall commodity trades.
An investment grade is a rating that signifies that a municipal or corporate bond presents a relatively low risk of default.
The Bloomberg Barclays Municipal High Yield (HY) Index is a flagship measure of US municipal tax -exempt high yield bond market.
Michigan Consumer Confidence Index: The Michigan Consumer Sentiment Index (MCSI) is a monthly survey of consumer confidence levels in the United States conducted by the University of Michigan. The survey is based on telephone interviews that gather information on consumer expectations for the economy.
Conference Board Measure: The Consumer Confidence Survey® reflects prevailing business conditions and likely developments for the months ahead. This monthly report details consumer attitudes, buying intentions, vacation plans, and consumer expectations for inflation, stock prices, and interest rates. Data are available by age, income, 9 regions, and top 8 states.
The Chicago Fed's National Financial Conditions Index (NFCI): provides a comprehensive weekly update on U.S. financial conditions in money markets, debt and equity markets and the traditional and "shadow" banking systems. Positive values of the NFCI indicate financial conditions that are tighter than average, while negative values indicate financial conditions that are looser than average.
Leveraged Loans – S&P LSTA Leveraged Loan Index, 6m T-Bills – ICE BofA 6-Month Treasury Bill Index, U.S. High Yield Corporate: 1-3 Years – ICE BofA U.S. High Yield 1-3 Year Index, Intermediate Municipal – Bloomberg 1-15 Yr Municipal Index, U.S. High Yield Corporate – Bloomberg U.S. High Yield Corporate Index, Intermediate IG Corporate – Bloomberg Intermediate Corporate Index, High Yield Municipal – Bloomberg 60% Tax-Exempt HY/40% LB Municipal Index
Normal Recession Scenario: Average of past 4 drawdowns plus 18 months of current annualized market yield, annualized between today and YE 2023.
Slow Growth Scenario: Average sector duration multiplied by 0.65 plus 18 months of current annualized market yield, annualized between today and YE 2023.
A collateralized loan obligation (CLO) is a single security backed by a pool of debt.
A leveraged loan is a type of loan that is extended to companies or individuals that already have considerable amounts of debt or poor credit history.
6M T-Bills: The 6 Month Treasury Bill Rate is the yield received for investing in a US government issued treasury bill that has a maturity of 6 months.
“U.S. High Yield Corporate” is represented using the U.S. High Yield Index “Intermediate Long Municipal” is represented by: 10% Bloomberg 5 Year Municipal Bond Index, 15% Bloomberg 7 Year Municipal Bond Index, 35% Bloomberg 10 Year Municipal Bond Index, 30% Bloomberg 15 Year Municipal Bond Index, 10% Bloomberg 20 Year Municipal Bond Index.
A high yield municipal bond is issued by a government. It is either not rated by the major credit rating agencies or has been given a rating below investment grade.
This presentation is for general information and education only. City National makes no representations or warranties in respect of this presentation and is not responsible for the accuracy, completeness or content of information contained in this presentation. City National is not responsible for, and expressly disclaims all liability for, damages of any kind arising out of use, reference to, or reliance on any information contained in or from the site. The information in this presentation should not be used to obtain credit or for any other commercial purpose nor should it be construed as tax, accounting, regulatory or legal advice. Rules in the areas of law, tax and accounting are subject to change and open to varying interpretations and you should seek professional advice from your advisor. Nothing in this presentation should be construed as an offer, or solicitation of an offer, to buy or sell any financial instrument. It should not be relied upon as specific investment advice directed to the viewer's specific investment objectives. Any financial instrument discussed in this presentation may not be suitable for the viewer. Each viewer must make his or her own investment decision, using an independent advisor if prudent, based on his or her own investment objective and financial situation. Prices and availability of financial instruments are subject to change without notice. Financial instruments denominated in a foreign currency are subject to exchange rate risk in addition to the risk of the investment. City National Bank (and its clients or associated persons) may, at times, engage in transactions in a manner inconsistent with this presentation and, with respect to particular securities and financial instruments discussed, may buy from or sell to clients or others on a principal basis. Past performance is not necessarily an indication of future results.
The expected returns shown do not include fees for trading costs (e.g., commissions) or any fees charged by your financial advisor. Please speak to your financial advisor for a complete understanding of all fees.
This information is provided pursuant to a specific request and is for informational purposes only. None of the material, nor its content, nor any copy of it, may be altered in any way, transmitted to, copied, or distributed to any other party, without the prior express written permission of City National Rochdale. Analytical results have many inherent limitations and no representation is made that any investor will or is likely to achieve results similar to those shown. Changes in the assumptions used may have a material impact on the derived performance presented. The views expressed are also subject to change based on market and other conditions.
City National Bank provides investment management services through its wholly owned subsidiary City National Rochdale, LLC, a registered investment advisor. Content from the June 30, 2022 presentation, "Outlook Update: Higher for Longer" is reprinted by permission from City National Rochdale.
City National (and its clients or associated persons) may, at times, engage in transactions in a manner inconsistent with this article and, with respect to particular securities and financial instruments discussed, may buy from or sell to clients or others on a principal basis. Past performance is not necessarily an indication of future results. This article may not be reproduced, distributed or further published by any person without the written consent of City National. Please cite source when quoting.
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