Core Equity: Q4 2023
Market Update:
Capitalizing on U.S. Exceptionalism
Key Points
- Risks to U.S. outlook diminishing, mild recession risk down to 50%.
- Prospects for 2024 stock and bond returns positive, but remain vulnerable to near-term correction.
- Expecting U.S. financial markets to continue to outperform global counterparts.
Defying most predictions, 2023 marked the return of investor optimism and surprising economic strength. Only a year ago, a full 98% of U.S. CEOs were preparing for recession in the next 12 to 18 months.*
Following that came a regional banking crisis, government debt ceiling drama and persistent geopolitical turmoil. If not for a surge in a handful of tech companies linked to artificial intelligence, the S&P 500 might have spent much of the first half of the year in the red. Yet through it all, U.S. economic growth continued to prove resilient, and a late-year rally supported by unexpectedly dovish shift in tone from the Federal Reserve (Fed) ultimately resulted in a banner year for both stocks and bonds.
Our expectations of recession resulted in us maintaining a moderately defensive positioning. However, from a broader perspective, we got many things right last year, including our higher for longer outlook on Fed interest rates; a recovery in the 60/40 portfolio after two historically negative years; and, perhaps most importantly, our conviction that U.S. equities would continue to outperform their international peers.
A core tenet of our investment philosophy, as laid out in CNR’s proprietary 4Ps framework, has been our approach to global asset allocation, which has consistently recognized what, we believe, are the benefits for investors of focusing on U.S. exceptionalism. Indeed, many of the abiding structural strengths of the U.S. economy — fiscal responsiveness, labor flexibility and innovative capacity — go a long way toward explaining why the U.S. has navigated the pandemic better than nearly all other countries.
With Europe teetering on recession as we enter 2024, and China slowing to its weakest non-COVID-19 growth rate in over three decades, prospects for the U.S. economy continue to appear more promising by comparison, and our probability of a mild recession has fallen close to the consensus 50%. Although some sort of period of economic weakness in the first half of the year still seems likely, cooling inflationary pressures are paving the way for a less restrictive Fed policy, which, along with ongoing consumer resilience, should help set the stage for a reacceleration in growth in the second half of the year.
Such an outlook is supportive for continued positive, albeit more modest, U.S. stock and bond returns in the year ahead. However, for markets, the over-pessimism that categorized expectations for 2023 has turned to an over-optimism for 2024. Since last fall, investors have shown a one-track mind, anticipating a perfect combination of falling inflation, solid economic growth and sustained corporate margins, all supported by as many as five Fed interest rate cuts, beginning as soon as March.
Chart 1: Gross Domestic Product (GDP)
%, indexed to “0.0” on Dec. 31, 2019
Source: Bloomberg, as of December 2023.
Past performance is no guarantee of future results.
That seems too aggressive to us, and we continue to expect a more modest two to three cuts beginning sometime around midyear. Despite considerable progress, the stickiness of service prices, remaining labor market imbalances and geopolitical developments all pose threats that could stall the disinflationary process underway, and we suspect Fed officials will stay on hold until there is more compelling evidence that inflation remains on a sustained downward path toward 2%.
For investors, the problem with one-track minds is that they are easy to derail. This argues for a cautious and opportunistic approach to increasing risk exposure, as we gain clarity on the direction of economic growth, corporate profits and interest rates. As we saw in February and September of last year, markets priced for perfection can be vulnerable when changing macro conditions force recalibration of expectations around the timing of Fed policy changes.
If 2023 reminded us of anything, it is how difficult it can be to predict the path of markets that can shift quickly over the short term. Our job, as we see it, is managing risks and working to ensure clients meet their financial goals. From that perspective, 2023 was a successful year for clients. We expect more of the same in 2024 and will continue our investment strategy of focusing on high-quality U.S. bonds and stocks. But we will also maintain our disciplined approach to investing, eyeing potential pullbacks over the coming months for better opportunities to diversify client portfolios into the lagging segments of the equity market like Mid small cap stocks and to extend duration in fixed income allocations ahead of the coming Fed easing cycle.
Chart 2: Index Performance
As of 12/31/23
Sources: FactSet, CNR Research, as of October 6, 2023.
Indices are unmanaged, and one cannot invest directly in an index. Past performance is not a guarantee of future results.
* The Conference Board Measure of CEO Confidence, as of Q4 2022.
Important Information
The views expressed represent the opinions of City National Rochdale, LLC (CNR) which are subject to change and are not intended as a forecast or guarantee of future results. Stated information is provided for informational purposes only, and should not be perceived as personalized investment, financial, legal or tax advice or a recommendation for any security. It is derived from proprietary and non-proprietary sources which have not been independently verified for accuracy or completeness. While CNR believes the information to be accurate and reliable, we do not claim or have responsibility for its completeness, accuracy, or reliability. Statements of future expectations,estimates, projections, and other forward-looking statements are based on available information and management’s view as of the time of these statements. Accordingly, such statements are inherently speculative as they are based on assumptions which may involve known and unknown risks and uncertainties. Actual results, performance or events may differ materially from those expressed or implied in such statements.
All investing is subject to risk, including the possible loss of the money you invest. 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 risk or loss. Past performance is no guarantee of future performance.
There are inherent risks with equity investing. These risks include, but are not limited to stock market, manager, or investment style. Stock markets tend to move in cycles, with periods of rising prices and periods of falling prices.
There are inherent risks with fixed income investing. These risks may include interest rate, call, credit, market, inflation, government policy, liquidity, or junkbond. When interest rates rise, bond prices fall.
Bloomberg risk is the weighted average risk of total volatilities for all portfolio holdings. Total Volatility per holding in Bloomberg is ex-ante (predicted) volatility that is based on the Bloomberg factor model.
Municipal securities. 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.
Index Definitions
The MSCI EAFE (Europe, Australasia, Far East) Index is a free float-adjusted market capitalization weighted index that is designed to measure developed equity market results, excluding the US and Canada.
The MSCI Emerging Markets Index is a free float-adjusted market capitalization weighted index that is designed to measure equity market results in the global emerging markets, consisting of more than 20 emerging market country indexes.
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 US It is not an exact list of the top 500 US companies by market cap because there are other criteria that the index includes.
Bloomberg Barclays US Aggregate Bond Index (LBUSTRUU): 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.
GT10: US Government Treasury Yield
Bloomberg Municipal Bond Index: The Bloomberg US Municipal Bond Index measures the performance of investment grade, US dollar-denominated, long-term tax-exempt bonds.
Bloomberg Municipal High Yield Bond Index: The Bloomberg Municipal High Yield Bond Index measures the performance of non-investment grade, US dollar-denominated, and non-rated, tax-exempt bonds.
S&P Leveraged Loan Indexes (S&P LL indexes) are capitalization-weighted syndicated loan indexes based upon market weightings, spreads and interest payments. The S&P/LSTA Leveraged Loan 100 Index (LL100) dates back to 2002 and is a daily tradable index for the US market that seeks to mirror the market-weighted performance of the largest institutional leveraged loans, as determined by criteria. Its ticker on Bloomberg is SPBDLLB.
Bloomberg US Corporate Bond Index: The Bloomberg Barclays US Corporate Bond Index measures the investment grade, fixed-rate, taxable corporate bond market. It includes USD-denominated securities publicly issued by US and non-US industrial, utility and financial issuers.
Bloomberg US High Yield Index: The Bloomberg US Corporate High Yield Index measures the performance of non-investment grade, US dollar-denominated, fixed-rate, taxable corporate bonds.
Bloomberg: LF98TRUU Index: The Bloomberg US Corporate High Yield Bond Index measures the USD-denominated, high yield, fixed-rate corporate bond market. Securities are classified as high yield if the middle rating of Moody’s, Fitch and S&P is Ba1/BB+/BB+ or below. Bonds from issuers with an emerging markets country of risk, based on Bloomberg EM country definition, are excluded. This is the total return index level.
Morningstar SPBDLLY Index: Yield to maturity time series of the Morningstar LSTA US Leveraged Loan 100 Index. The Morningstar LSTA US Leveraged Loan Index is a market-value weighted index designed to measure the performance of the US leveraged loan market.
Bloomberg Investment Grade Index: The Bloomberg US Investment Grade Corporate Bond Index measures the performance of investment grade, corporate, fixed-rate bonds with maturities of one year or more.
Bloomberg Municipal Bond Index: measures the performance of investment grade, US dollar denominated, long term tax exempt bonds.
Bloomberg US Treasury Index: includes all publicly issued, U.S. Treasury securities that are rated investment grade, and have $250 million or more of outstanding face value.
Investment Grade (IG) Municipal Bond Index: The Bloomberg US Municipal Bond Index measures the performance of investment grade, US dollar-denominated, long-term tax-exempt bonds.
High Yield (HY) Municipal Bond Index: The Bloomberg Municipal High Yield Bond Index measures the performance of non-investment grade, US dollar-denominated, and non-rated, tax-exempt bonds.
Definitions
Yield to Worst (YTW) is the lower of the yield to maturity or the yield to call. It is essentially the lowest potential rate of return for a bond, excluding delinquency or default.
P/E Ratio: The price-to-earnings ratio (P/E ratio) is the ratio for valuing a company that measures its current share price relative to its earnings per share (EPS).
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 September 30, 2022. City National Rochdale proprietary ranking system utilizing MSCI and FactSet data.
Non-deposit investment Products are: • not FDIC insured • not Bank guaranteed • may lose value
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