On the Radar

City National Rochdale, | Nov. 23, 2020

FAQs on the Markets and Economy

What does the resurgence in COVID-19 mean for the global economy?

The global economy has clawed back about 60% of the output lost in the first half of the year, but recoveries in most parts of the world have already slowed, and prospects now vary according to success in controlling the virus and the policy response.

Recent vaccine news has been very encouraging, lifting the long-term outlook, but the boost to economic activity is unlikely to come until later next year. In the near term, we expect global growth will continue to moderate as fiscal support wanes, the reopening boost to activity after lockdowns fades, and many virus containment measures are either maintained or tightened.

For developed economies, we expect the U.S. to outperform Europe, and for China and some other parts of Asia to pull ahead in emerging markets, with India and Latin America as the laggards.

In Europe, a second wave of COVID has yet again subjected economies to substantial restrictions on daily life, and is threatening to push some countries back into recession. With the virus still spreading quickly and lockdowns likely to be extended, the hit to economic activity will probably get worse before it gets better.

The U.S. economy is likely to prove more resilient. Nevertheless, with the recent surge of infections across the country prompting more states to reimpose restrictions on activity, and key fiscal measures expiring, the next few months are expected to be challenging.

China and other emerging Asia economies, on the other hand, should continue to lead the global recovery in coming months, thanks to better success in containing the virus and effective stimulus response, though parts of South Asia will likely struggle more from a larger virus prevalence and weaker tourism.

Overall, CPI has moderated considerably since the run-up in prices following the post-lockdown pent-up demand surge in spending. When looking at a short-term trend, the three-month annualized CPI peaked at 6.3% in August, and now stands at 2.5%. The yearly change is at just 1.2% (see chart).

The softer data is clearly reflecting the reversal of the imbalances of supply and demand during the worst of the lockdown. Since then, supply chains have reopened to help meet demand.

Inflationary pressures are expected to continue to subside, as long as the coronavirus is a concern. After the virus is under control, we believe it will stay low due to the high unemployment rate. It will not be until the economy reaches full employment that price pressures will move up in a fashion that will concern the Fed.

Since February, retail sales have been growing close to 5.0%, well above the 4.0% average increase of this past expansion. They have increased in each of the past six months, and total sales have moved above the long-term trend line (see chart).

Retail sales measure the sales of goods, not services. The sales of services measured in the personal spending report, issued later in the month, are still below the pre-pandemic peak. It is being held back by social distancing requirements.

Looking forward, November and December could have softer growth. States and cities may be reimposing restrictions on indoor dining and non-essential businesses (gyms, hair salons, etc.). Many households plan to spend less on the holidays than last year. Also, some holiday sales may have been pulled forward. Amazon had their Prime Day in October, and Walmart’s big Black Friday event was held last week.

Economic and financial disruptions caused by the public health crisis are testing municipal bond issuers’ resiliency and the durability of investor credit underwriting procedures. The impact of credit quality is disparate and unevenly distributed across regions and sectors, underscoring the importance of rigorous research analysis.

The CNR team is carefully evaluating potential operational or fiscal implications over the near term that could transition into permanent longer-term issuer weakness. For example, senior living facilities’ social risks, dislocation in industrial enterprises’ business positions or evolving real estate trends within the land-secured sector, to name a few.

Pandemic-induced credit stress is surfacing in mostly more speculative areas of the high yield municipal market. According to Municipal Market Analytics (MMA) data, first-time issuer defaults and impairments (i.e., reserve draws, covenant violations, insurance claims, restructuring, etc.) are rising YTD at the quickest pace since 2012. They will likely remain elevated over the near-to-medium term versus historical trends, but still relatively low versus the market size.

The uptick in defaults and impairments is not only attributable to newly developed distress, but the pull-forward and acceleration of activity was likely to have occurred regardless, in our view. The CNR team was concerned about declining credit quality in some bond transactions a few years before the pandemic. It implemented defensive measures within its portfolio, such as less “risky” sector/security selection, maintaining credit protections, and raising the overall quality.

The highly experienced CNR Municipal High Income Fund Team has traversed these periods before, has the knowledge and expertise to conduct proper due diligence, and maintains a discerning approach to sourcing value opportunities that may reward the funds’ investors over time.

Optimism over vaccine progress and extremely strong earnings results have helped to push stocks to record highs in spite of record new COVID-19 cases and hospitalizations.

To a large extent, we think the market reaction has been justified. The visibility of economic growth in the medium term has improved recently, now that the election is behind us, while vaccine development efforts have been much better than expected, and because of this, the confidence in the outlook for corporate profit growth has improved.

However, with the recent increase in COVID cases nationally, renewed restrictions on economic activity in many jurisdictions, and failure of lawmakers to pass additional stimulus, the next few months should prove challenging for the economy.

As the market attempts to balance this weakened near-term outlook against an improving long-term outlook, increases in market volatility and more modest returns are likely, especially after the strong run-up in stock prices in early November. A potential pullback in stock prices is also possible, though we would view this as a buying opportunity.

Overall, we continue to prefer U.S. stocks over non-U.S. developed markets and EM Asia over other emerging markets. While valuations in S&P 500 stocks appear full, other areas, especially in the high-dividend-paying stocks, look attractive to us. We remain focused on high-quality companies with strong business models selling at reasonable valuations.

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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 of the date of this document and are subject to change.

There are inherent risks with equity investing. These include, but are not limited to, stock market, manager, or investment style risks. Stock markets tend to move in cycles, with periods of rising prices and periods of falling prices.

Investing in international markets carries risks such as currency fluctuation, regulatory risks, and economic and political instability.

Emerging markets involve heightened risks related to the same factors as well as increased volatility, lower trading volume, and less liquidity. Emerging markets can have greater custodial and operational risks, and less developed legal and accounting systems, than developed markets.

There are inherent risks with fixed income investing. These may include, but are not limited to, interest rate, call, credit, market, inflation, government policy, liquidity, or junk bond risks. When interest rates rise, bond prices fall. This risk is heightened with investments in longer-duration fixed income securities and during periods when prevailing interest rates are low or negative.

Investments in below-investment-grade debt securities, which are usually called “high-yield” or “junk” bonds, are typically in weaker financial health, and such securities can be harder to value and sell and their prices can be more volatile than more highly rated securities. While these securities generally have higher rates of interest, they also involve greater risk of default than do securities of a higher-quality rating.

The yields and market values of municipal securities may be more affected by changes in tax rates and policies than similar income-bearing taxable securities. Certain investors’ incomes may be subject to the federal Alternative Minimum Tax (AMT), and taxable gains are also possible.

Investments in the municipal securities of a particular state or territory may be subject to the risk that changes in the economic conditions of that state or territory will negatively impact performance. These events may include severe financial difficulties and continued budget deficits, economic or political policy changes, tax base erosion, state constitutional limits on tax increases, and changes in the credit ratings.

Investments in emerging markets bonds may be substantially more volatile, and substantially less liquid, than the bonds of governments, government agencies, and government-owned corporations located in more developed foreign markets.

Returns include the reinvestment of interest and dividends.

Investing involves risk, including the loss of principal.

As with any investment strategy, there is no guarantee that investment objectives will be met, and investors may lose money.

Past performance is no guarantee of future performance.

Index Definitions

S&P 500 Index (S&P500) is a stock market index that tracks the 500 most widely held stocks on the New York Stock Exchange or NASDAQ. It seeks to represent the entire stock market by reflecting the risk and return of all large-cap companies.

Dow Jones US High Dividend Yield Index serves as a benchmark for income seeking equity investors. The index is designed to measure the performance of 80 high yield companies within the S&P 500 and is equally weighted to best represent the performance of this group, regardless of constituent size.

S&P 500 Growth Index measures growth stocks using three factors: sales growth, the ratio of earnings change to price, and momentum. S&P Style Indices divide the complete market capitalization of each parent index into growth and value segments.

A consumer price index (CPI) measures changes in the price level of a market basket of consumer goods and services purchased by households. The CPI is a statistical estimate constructed using the prices of a sample of representative items whose prices are collected periodically.

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