Investing During Increased Volatility
While investors have been buffeted by one of the worst annual first quarter starts in history, underlying positive fundamentals and an agile approach to risk management can manage the challenges ahead, according to City National Rochdale's investment leaders.
Managers at City National Rochdale addressed the topic of investing during turbulent times during a recent webinar. Managers at City National Rochdale, the bank's investment advisory organization, addressed the topic of investing during turbulent times during a recent webinar. The headwinds of rising interest rates, higher inflation and increased global uncertainty are impacting the U.S. economy, corporate profits and valuations. While risks have grown and greater clarity is needed on the inflation outlook before markets can find a durable bottom, the managers believe that positive fundamentals in the U.S. economy will provide support over time.
While City National Rochdale CEO Garrett D'Alessandro said that GDP growth forecasts were revised downward to 2.5% to 3.5% for 2022, a recession is not likely in 2022 nor during the first half of 2023, according to Rochdale forecasts. Inflation pressure is anticipated to moderate from 5% to 6% during the second half of 2022 . Corporate profits are anticipated to stay strong at 5% to 11% by year's end.
“Market signals indicate that now is the time to own the strongest U.S. companies in your portfolio, whether for growth or income equity," said D'Alessandro. “While we're generally cautious in the near-term, we want everybody to understand this is a normal part of the process and that this is the time to stay on with your long-term strategy."
Uncertainty regarding the economy's direction is one of the challenges facing investors today. There are three possible scenarios for economic growth, with Rochdale's team estimating a 30% chance of normal growth, 40% chance of slow growth, and a 30% chance of mild recession.
“The Fed doesn't know what will happen, no firm on Wall Street knows this, and this is one of the most unpredictable, uncertain scenarios we've faced in a generation," said D'Alessandro.
While City National Rochdale's latest Speedometer report shows enough strength to sustain the economy for the next 12 months, the investment team is watching geopolitical events and the U.S. Federal Reserve carefully for their impacts on economic forecasting and the markets.
Positive indicators include the U.S. economic outlook, consumer sentiment, disposable personal income, the labor market, consumer spending, fiscal policy, the business outlook, leading indexes, corporate profit growth and credit availability. In addition, a variety of fundamentals are at peak levels, according to data from Bloomberg, such as real GDP, corporate profits, household net worth and stock prices.
TIGHTENING FED POLICY & RISING INTEREST RATES
“Never before in the history of the United States has the strength of the economy and the levels of economic achievement been this robust," said D'Alessandro. “So, when you have an economy this good, it can handle these interest rate increases."
While numerous factors are driving inflation, including supply chain bottlenecks, the shift from goods to services, the impact of the stimulus, reduced labor supply and the Ukraine/Russia shock to the supply chain, some of those issues are easing.
D'Alessandro and the Rochdale team believe that stagflation is not a danger, but there is a chance it could occur due to the combination of low unemployment, rising inflation, and slower economic growth. But the political will to address inflation should reduce the elevated levels of inflation seen now by the end of the year.
“There's a clear, unambiguous disdain for inflation from the Biden administration and the Fed," said D'Alessandro. “We have confidence that the Fed understands the playbook and can execute the playbook to get inflation under control. What we don't know is how high they'll have to hike the rates and whether that will get us into a slow GDP economy or mild recession."
INVESTMENT OPPORTUNITIES IN A VOLATILE ENVIRONMENT
The U.S. 10-year Treasury yield is anticipated to end 2022 between 2.25% and 2.75%, according to data from Bloomberg, the Federal Funds Rate implied policy level and City National Rochdale research.
“It's not a foregone conclusion that a recession has to occur during a Fed tightening," said Rochdale's co-director of fixed income, Charles Luke. “The past few years have been highly irregular, and the process of normalization will be bumpy but welcome."
There are market opportunities for fixed-income investments, particularly for U.S. high yield corporate bonds and high yield municipal bonds. The lack of liquidity has pushed rates higher and underlying municipal fundamentals are positive, Luke added, citing data from Bloomberg. Tax-sensitive investors may want to investigate these opportunities with their advisors.
Some alternative investments, such as reinsurance, direct lending, capital leasing and structured credit — while less common — may be appealing for investors. Overall, these investments have higher return expectations but greater potential for volatility than core fixed-income investments, according to Bloomberg data.
“While public markets are clearly volatile, we've seen some stability in some of the less talked about segments of our clients' portfolios," said City National Rochdale's director of investment solutions and research, Tom Ehrlein.
Rochdale takes a measured approach to alternative investments, looking for opportunities while mitigating risk for investors.
ELEVATED GLOBAL & GEOPOLITICAL UNCERTAINTY
While global economic activity is slowing, the U.S. is in the best position in the world economically. City National Rochdale remains underweight on European equities because of the risks of recession and stagnation.
Among the issues carefully watched by Rochdale's team are the war in Ukraine and its impact on inflation and supply chain issues. Europe is more vulnerable to energy and food shock, with higher gas prices than in the U.S.
Rochdale's investment managers are neutral on equities, reducing Asian exposure. They are watching Asia carefully given China's drastic COVID-19 policy that has slowed its economy and has triggered increased financial volatility.
INVESTING DURING INCREASED MARKET VOLATILITY
While investors are nervous about market volatility, corrections are part of normal market activity. Rochdale advises its clients to stay the course, even during highly volatile periods.
Despite higher interest rates and market volatility, stocks continue to be more attractive than bonds.
Overall, Rochdale's managers remain cautious in the near term and advise their clients to anticipate modest returns with increased volatility across many asset classes in the longer term.
Over the long-term, Rochdale's managers are watching trends to see if there's a paradigm shift to higher inflation for a longer period. Each moment in history produces its own unique optimal asset allocation for risk and returns. The investment team at Rochdale continues to monitor the challenges and opportunities in today's economic environment to balance risks and rewards for their clients.
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