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Forward-Looking Six to Nine Months


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Global Economic Outlook

Against the fading boost from economic reopening, the global outlook is facing increased headwinds. The pivot by central bankers to quash the fastest inflation in a generation, the shock to global commodities from Russia’s invasion of Ukraine, and the potential of China’s COVID-19 lockdowns to further disrupt world supply chains, all point to moderating growth ahead. However, the impact of these forces is expected to be felt unevenly across economies. Europe, for example, is most vulnerable to the fallout from the War in Ukraine given its more significant trade relationship with Russia and in particular its reliance on energy imports. Meanwhile, China continues to experience pandemic setbacks to economic normalization and export growth as it grapples with getting COVID-19 under control.

 

While the US is not immune to these global forces, households and business fundamentals remain healthy and resilient, making recession a low probability through the first half of 2023. Still, the removal of Fed support and higher borrowing costs will likely lead to slower economic growth and an increased possibility of policy missteps. With inflation consistently rising above expectations, policymakers are now laying the groundwork for their most aggressive tightening cycle in decades. Although, we believe current US economic strength will lessen the impact of interest rate increases over the next twelve months, the outlook beyond the first half of 2023 has grown increasingly clouded and we have broadened our range of potential outcomes from normal growth, to slower and a milder recession.

Fixed Income Outlook

Higher-than-expected inflation readings have shocked the market and led to market projections of ten 25 bps Federal Reserve interest rate hikes in 2022. Supply issues remain and have been exacerbated by the War in Ukraine, which has driven commodity and food prices higher. While the Fed can fight traditional sources of inflation - primarily demand related - it is critical that the now entrenched supply issues brought on by COVID-19 start to improve. Despite the unprecedented situation, long-term interest rates are still at levels consistent with the average of the last 10-years, although the sharp adjustment off of the pandemic floor created high volatility across fixed income.

With fixed income markets having experienced the worst sell-off in 40 years, the increase in rates has made certain areas of the market attractive, specifically high yield which offers low-interest rate exposure coupled with yield levels not seen since the start of the pandemic. Further, municipal bonds relative to corporates are trading at attractive levels. Although we expect rates to stabilize and finish the year around 2.50-3.00%, we're still cautious of adding interest rate exposure and have lowered our investment grade return forecasts to 0-2% while our high yield expectations range from 3-6%, slightly higher than where we began the year.

Equity Outlook

Despite increased headwinds, we continue to think the strength of underlying fundamental conditions should offer broader support to US stock prices over time. Corrections tend not to become prolonged bear markets when the outlook for economic and corporate profit growth remains positive. However, we are also likely headed toward the later stages of this economic cycle, which is historically marked by more modest returns and higher volatility. Equity markets tend to hold up reasonably well during this period, but as the cycle advances, liquidity is withdrawn and growth slows, the investment backdrop becomes more challenging.

Given the strong relative advantages the US economy enjoys, we continue to favor US equities over other regions of the world. Even with sharply higher interest rates, US stock valuations remain attractive relative to bond valuations. Meanwhile, corporate profits results continue to be strong, with forward guidance so far providing some reassurance that S&P 500 earnings can still grow between 5% -11% this year. This view supports our emphasis on high-quality stocks selling at reasonable prices that can both grow earnings and dividends at an above-average pace, and that also have durable franchises and strong management teams to weather a recession should one occur.

Our Proprietary Global Economic & Market Summary Indicators

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  • Monetary Policy

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    Monetary Policy

    What we see

    Monetary policy is one of two ways the government can influence the economy and financial markets. By manipulating interest rates, the Federal Reserve can raise or lower the cost of money to stabilize or stimulate the economy. For example, if the cost of credit is reduced, more people and firms will borrow money and the economy will grow. Higher interest rates will increase the cost of its debt, reducing borrowing and company profits, and may slow economic growth.
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  • US Economic Outlook

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    US Economic Outlook

    What we see

    City National Rochdale's investment and portfolio strategy is driven by our macroeconomic analysis. Timely economic forecasting is very difficult to do but extremely important, especially as the significance of economic information to financial markets continues to rise. To form a reliable outlook for the economy, City National Rochdale utilizes a comprehensive internal research effort that is complemented by an extensive set of external research from some of Wall Street's leading strategists. This approach allows us to develop a complete and dependable forecast of economic conditions. Our economic outlook indicator provides our forecasted expectation for how well the U.S. economy will perform over the next 3-6 months.
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  • Yield Curve

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    Yield Curve

    What we see

    The shape of the yield curve gives an idea of future interest rate changes and economic activity. There are three common yield curve shapes: normal, inverted, and flat. A normal yield curve is one in which longer maturity bonds have a higher yield compared to shorter-term bonds, due to the risks associated with time, and can signal improving economic growth. An inverted yield curve is one in which the shorter-term yields are higher than the longer-term yields, which can be a sign of upcoming recession. In a flat or humped yield curve, the shorter- and longer-term yields are very close to each other, which is also a predictor of an economic transition.
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  • Consumer Sentiment

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    Consumer Sentiment

    What we see

    How consumers feel about their overall financial health as well as that of the economy on the short and long term. This is an important indicator, as the consumer is the largest driver of the U.S. economy.
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  • Disposable Personal Income

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    Disposable Personal Income

    What we see

    The amount of money households have available for spending and saving after income taxes. A change in a household's real income is by far the most important factor in determining how much that household will spend. Other factors, such as home values or financial savings, matter as well but to a significantly lesser extent.
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  • Labor Market

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    Labor Market

    What we see

    Research has shown that employment and income expectations, along with credit availability, are the most important determinants of consumer spending. Personal consumption amounts to roughly 70% of GDP, making a strong labor market essential to a healthy economy.
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  • Housing / Mortgages

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    Housing / Mortgages

    What we see

    Housing is an important indicator of the overall economy and a key driver of investment and job growth. We look at such things as starts, permits, foreclosures, delinquencies, and bank lending to assess the sector's health.
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  • Consumer Spending

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    Consumer Spending

    What we see

    Aggregate level of consumer spending. Since consumers are the largest driver of the U.S. economy, their spending patterns have a large impact on overall economic activity.
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  • Interest Rates

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    Interest Rates

    What we see

    Interest rates control the flow of money in the economy. High interest rates curb inflation, but also slow down the economy. Low interest rates stimulate the economy, but could lead to inflation. Interest rates affect the economy slowly. When the Federal Reserve changes the Fed Funds rate, it can take 12-18 months for the effect of the change to percolate throughout the entire economy.
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  • Fiscal Policy

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    Fiscal Policy

    What we see

    Changes in tax rates, regulation, and government spending affect the decision-making process of consumers and businesses. By changing tax laws, the government can effectively modify the amount of disposable income available to taxpayers or raise the costs for businesses. However, this process takes time, as the money needs to wind its way through the economy, creating a significant lag between the implementation of fiscal policy and its effect on the economy.
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  • Business Outlook Spending/Surveys

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    Business Outlook Spending/Surveys

    What we see

    Surveys of the business community on current and expected trends. This is a gauge on businesses' spending plans that provides an insight into wages, inflation, and capital equipment spending.
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  • Leading Indexes

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    Leading Indexes

    What we see

    We look at a number of indices that have a strong track record in anticipating turns in business cycles. These include measures of production, employment, income, and sales, which have a strong correlation to subsequent economic activity. These indices provide a comprehensive summary gauge of future U.S. economic conditions, with an average lead of 12 months at business cycle peaks and 6 months at business cycle troughs.
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  • Corporate Profit Growth

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    Corporate Profit Growth

    What we see

    Corporate earnings have a significant influence on the stock market as they ultimately drive stock prices. The value of securities is the present value of all future cash flows. Companies either reinvest earnings or pay them out to shareholders as dividends, which directly impact the stock price. As future expectations increase, future projections of company earnings will also increase.
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  • International Economic Outlook

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    International Economic Outlook

    What we see

    The world has become increasingly interconnected through trade and the flow of capital, and emerging markets in particular have risen in importance as drivers of global growth. Moreover, we believe a global perspective is integral to any investment strategy.
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  • Political Environment

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    Political Environment

    What we see

    The overall political climate in the U.S. with a focus on whether it will be supportive or restrictive to economic growth. For instance, while the state of discourse in politics can be tense and deadlocked, it may not be restrictive to growth. Conversely, there could be bipartisan action that is restrictive to growth. It is important to note that this category refers not to the state of discourse, but to the market impact.
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  • Inflation

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    Inflation

    What we see

    While a slow, persistent rise in prices is consistent with a healthy, growing economy, a rapid increase in inflation, especially if unanticipated, can be harmful. Inflation means higher consumer prices, which often slows sales and reduces profits. Higher prices often lead to higher interest rates. Over time, inflation can also wear away at the value of stocks, which is why it is crucial to monitor.
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  • Credit Demand / Availability

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    Credit Demand / Availability

    What we see

    Availability of credit from banks and the overall financial sector to provide capital to the economy. Restrictive credit conditions are a headwind to economic activity, while accommodating conditions may boost it.
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  • Energy Costs

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    Energy Costs

    What we see

    Significant changes in energy/oil prices can have important but differing impacts on the overall economy. Higher energy prices act as a tax on consumers and businesses, absorbing money that would normally be used to buy other goods. However, they can also boost production and investment in the mining and energy sectors of the economy. Lower energy prices can increase consumer spending and lower manufacturing costs.
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  • Equity Market Valuation

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    Equity Market Valuation

    What we see

    Questions of value are always subjective and relative. We believe that equity market valuation should be measured against both the value of stocks at their historical levels and the other investment options available. A stock is worth its future earnings, but that involves a degree of uncertainty, which affects its price depending on the degree. In addition, investors have many other asset classes to choose from, including corporate bonds, Treasury bonds, alternative investments, and the like. We look at all of these factors before we determine what we believe to be a fair equity market valuation.
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  • Geopolitical Risk

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    Geopolitical Risk

    What we see

    Geopolitical risk examines how geography and economics influence politics and international relations. Geopolitical risk includes the risk associated with international policy, trade, and global financial market stability, as well as wars, terrorist acts, tensions between states, and other events that can impact the normal and peaceful course of international relations.
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