On the Radar

City National Rochdale, | Sep. 28, 2020

FAQs on the Markets and Economy

Why is CNR underweight in European Equities?

After apparent progress in stemming the coronavirus outbreak this spring, the recent resurgence of infections across Europe is raising concerns about the sustainability of the region’s economic recovery.

The Organisation for Economic Co-operation and Development (OEC) warned last week that the recovery is losing pace and will need support from governments and central banks for some time, while European Central Bank (ECB) President Lagarde said the outlook is still “very uncertain.”

The further decline in the Eurozone Composite PMI in September adds to the evidence that the initial rebound in activity is already running out of steam. Even if governments manage to avoid a return to stricter containment measures, lower demand from cautious consumers will likely weigh on activity this winter. Overall, output looks set to remain below its pre-crisis level at least until the end of 2022, although there will be significant discrepancies between countries.

Our concerns with European Equities have been the region’s weaker growth prospects, higher exposure to global/trade headwinds, negative yields that affect banks’ profitability, a less favorable sector representation in the market structure and politics that hinder market/economic reforms. These issues, which led to its past underperformance, are unlikely to ease going forward.

The challenge facing investors today is how to construct portfolios in a slow and uncertain macroeconomic environment. Given this, we remain overweight in U.S. equities, which have a greater share of high-quality and growth companies, and underweight in European Equities due to their more cyclical exposure and less resilience to a downside scenario.

The Fed updated its economic outlook, and it is more optimistic than previously thought. It revised its 2020 GDP projection to be a decline of 3.7%, a vast improvement from June’s expectation of -6.5%. It is pleased and surprised at the economic response from the stimulus and relief packages from the Fed and the federal government.

In looking at the phases of the economy (see chart), the blue section reflects the contraction phase from February to April, the period of the lockdown and massive layoffs. We are now in the transition phase (light blue). This is the period of time when some businesses have fully reopened, some have partially reopened, some have yet to reopen, and some are still trying to figure out if they can stay open. It will probably last until year-end. Then the economy will transition into the recovery phase (grey), when the economy will most likely continue to grow at a more consistent pace until the amount of output reaches the previous peak. After that will be the expansion phase.

Based upon the Fed’s projections of GDP growth, the country’s economic output is not expected to surpass the previous peak (fourth quarter of 2019) until the fourth quarter of 2021.

Each quarter, the Fed updates its projections for GDP, employment and CPI.

The housing market continues to be one of the main engines of growth for this economy. Low mortgage rates and pent-up demand are driving demand.

New home sales are on a strong upward trend. This is one of the more important housing measurements, since new home construction creates many jobs, unlike the sale of an existing home. In August, new home sales topped 1 million, the first time above this threshold since 2006 (see chart). Most of the demand for new homes is in the South, as there is a shift away from higher-cost areas like the Northeast and West.

This data is consistent with other housing metrics, most notably, home builders’ confidence. This index has increased for five consecutive months to the level of 83 in September. It stands at an all-time high in the 35-year history of the series.

With time running out on the current legislative calendar, the partisan battle over Justice Ginsburg’s replacement adds to an already contentious stalemate between lawmakers over the size and shape of further stimulus. As a result, we now believe it’s increasingly unlikely that a new bill will pass before the election, and it’s unclear at this point how conducive the post-election environment will be for political compromise.

While there is general agreement in Congress that more aid is needed, the sticking point continues to be reconciling the priorities between Democrats and Republicans, as well as the size of additional spending.

Many issues are on the table, including an extension of boosted unemployment payments, another round of direct cash payments, increased assistance to state and local governments, funding for schools and students, hazard pay and liability immunity.

Much of the economic and market strength we have seen over the past few months can be directly attributed to the unprecedented aid coming out of Washington. Trillions of dollars have already been spent to keep families and small businesses afloat during the pandemic — and it has largely worked.

However, many of these emergency programs have now expired or have been exhausted. Unfortunately, all this is coming at a time when the recovery seems to be losing some momentum and COVID-19 cases are again showing signs of increasing across the country.

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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

The Eurozone PMI Composite Output Index tracks business trends across both the manufacturing and service sectors, based on data collected from a representative panel of over 5,000 companies (60 percent from the manufacturing sector and 40 percent from the services sector).

The Consumer Price Index (CPI) is a measure of the average change overtime in the prices paid by urban consumers for a market basket of consumer goods and services.

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