July 2023 Market Update

A Deep Dive into CNR’s Economic and Investment Outlook


July 27, 2023


2023-07-27_Market Update.pdf
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Market Update Summary

In July’s Market Update, Karen Reynolds Sharkey, the Head of Client Advisory and Services at City National Bank, hosted a Q&A discussion focusing on updates to CNR’s economic and investment outlook. Joining her were:

  • Garrett D'Alessandro
  • Charles Luke
  • Rachael Crane

Although economic growth has been resilient this far, the majority of economic indicators CNR monitors continue to suggest that a mild recession is likely sometime later this year. With monetary policy entering restrictive territory only recently, and the Fed likely to stay higher for longer, downside risk should become more apparent in the coming months. Equity markets appear to be anticipating a quick return to a low-inflation, lower-interest rate environment and are likely to be disappointed. The speakers advise remaining underweight in stocks, and instead investing in fixed income and cash management returns. They emphasize the opportunities projected in short-term investment grade corporate bonds, high yield bonds and structured credit.

Q1: The US economy has shown surprising strength this year. What has kept growth resilient, and do you still think recession in the near term is a high probability?

Mr. D'Alessandro, the CEO of City National Rochdale, noted that growth has been better than expected so far this year. The resiliency of the economy, along with some recent positive developments, including progress on inflation, an approaching end to the Fed’s rate hiking cycle and actions by authorities to contain banking system turbulence, have moderated risks to the outlook.  

However, CNR continues to believe a mild recession is in the cards sometime later in 2023 or early 2024. Consumer strength, backed by a strong labor market, has kept the economy from slipping into recession so far, but this strength is expected to be tested in coming quarters. Mr. D'Alessandro highlighted the depletion of savings that were mailed out by the government, and the increase in delinquency rates and household debt payments as building headwinds for households. He also noted that low unemployment is not necessarily a reliable predictor of future economic conditions. Credit conditions continue to tighten, and restriction in credit availability has historically led to a slowdown in the economy.

CNR now sees a 74% chance the economy will fall into recession, down from 78% last month, but has more confidence the recession will be relatively short and mild by historical standards, given the strength of underlying household and business fundamentals.

Q2: Growth has remained resilient so far, and inflation, while moderating, is still too strong. How does this complicate things for the Fed?

Charles Luke pointed out that, although economic growth has remained resilient, and inflation is moderating, it still remains too strong for the Fed. This complicates their decision-making process as they aim to beat inflation. Wage growth is seen as a key factor by officials that can bring down inflation, and, until the job market loosens, it will be difficult for the Fed to cut rates. Mr. Luke also noted that the market's expectations for rate cuts have consistently been wrong, and he advises not to fight the Fed. The overall outlook suggests that the Fed will likely stay on hold for an extended period, and while a sustained slowdown in growth is expected, it may take longer than initially anticipated. 

Q3: Given the macro outlook that Garrett and Charles just described, how are CNR Portfolio Managers positioning client portfolios?

Given the highlighted uncertainty and elevated recession risk, Rachael Crane stated that CNR portfolio managers are maintaining their mild defensive positioning with a slight underweight position in equities. CNR currently sees better risk reward and plenty of opportunities in fixed income. It’s been a decade since bond yields have been this attractive, and, even though inflation is trending down, various yields have remained elevated, increasing the real rate of return. Short-term T-Bills and cash-like alternatives have garnered the most attention, but short to intermediate yields in both municipal bonds and corporates offer additional opportunities. Bond allocations not only lower overall portfolio volatility, but they also historically perform better than stocks in recessionary periods.

Ms. Crane noted that they are monitoring various factors, such as increased confidence in the economic and corporate profit outlook, signs the Fed might begin easing policy and improvement in geopolitical tensions, to potentially increase equity exposure in the future. Overall, they believe having some dry powder and getting paid while waiting for more attractive opportunities in the equity markets is a sensible approach.

Q4: Growth equities have had a strong start to the year, and conservative and dividend stocks have not performed well. What should we make of this?

Mr. D’Alessandro discussed the strong performance of the S&P 500 this year, but noted that a very large percentage of the index’s return has been driven by a handful of mega-cap tech names and enthusiasm over developments in artificial intelligence. Although breadth has improved recently, performance outside tech and a few other growth sectors has been much more muted.  CNR will need to see greater participation from more economic sensitive sectors of the market to have greater confidence in the rally. He also noted that, while dividend stocks have not performed well this year, last year’s performance was very strong, and, over the longer term, these stocks have provided beneficial contributions to client portfolios. Dividend stocks also look more attractive, relative to the broader market.

Overall, CNR remains skeptical about the sustainability of the current stock market rally, especially given their outlook for a recession in the next few quarters. Investor expectations for economic growth and the path of interest rates is too optimistic, Mr. D’Alessandro noted, and earnings disappointment ahead could be a source of renewed weakness in equity prices.

Q5: Bond markets have also seen a recovery this year. How is CNR viewing the fixed income market and taking advantage of opportunities?

Charles Luke reviewed the recovery of the bond market and the positive impact it has had on overall client portfolio returns. He highlighted the strong performance of high yield corporate and municipal bonds this year, and that CNR expects the fixed income environment to remain healthy. While he expressed caution regarding the current pricing of high yield corporate debt, stating that spreads are too small and may lead to increased volatility in the future, when managed properly, high yield consistently outperforms investment grade and contributes to long-term performance.

In the current environment, CNR believes that investment grade taxable and municipal bonds offer the potential for attractive returns with less risk. Mr. Luke said CNR remains cautious in adding interest rate exposure, especially with signs of sticky inflation and still solid economic data, which will force the Fed to keep policy tight longer than the market expects. At the same time, the competing influences of inflation and growth are expected to keep volatility high in the bond market, so they recommend short-term bonds and a reduction in opportunistic income allocations in favor of investment grade over the next 12 months.

Q6: Putting this all together, how are you managing portfolios to meet client goals and expectations?

Rachael Crane discussed the importance of protecting client portfolios by carefully managing risks and having a disciplined, fundamentally driven investment process. She emphasized the need to avoid knee-jerk reactions and emotional decision-making based on short-term market fluctuations, which can lead to longer term underperformance. Ms. Crane also highlighted the value of intelligently personalizing client portfolios, including considering liquidity constraints and tax management. The overall objective of CNR portfolio managers is to increase the probability of reaching client goals while minimizing volatility.



Important Information

Equity investing strategies & products.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.

Fixed Income investing strategies & products.There are inherent risks with fixed income investing. These risks 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.

Investing in international markets.There are inherent risks with international investing. These risks include, but are not limited to, 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. In addition, emerging markets can have greater custodial and operational risks and less developed legal and accounting systems than developed markets. 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 moredeveloped foreign markets.

High yield securities.Investments in below-investment-grade debt securities, which are usually called “high yield” or “junk bonds,” are typically in weaker financial health. 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.

Real estate sector or REITs.Concentrating assets in the real estate sector or REITs may disproportionately subject a portfolio to the risks of that industry, including the loss of value because of adverse developments affecting the real estate industry and real property values. Investments in REITs may be subject to increased price volatility and liquidity risk; concentration risk is high.

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.

All investment strategies have the potential for profit or loss; changes in investment strategies, contributions or withdrawals may materially alter the performance and results of a portfolio. Different types of investments involve varying degrees of risk, and there can be no assurance that any specific investment will be suitable or profitable for a client's investment portfolio.

Returns include the reinvestment of interest and dividends.

Indices are unmanaged, and one cannot invest directly in an index. Index returns do not reflect a deduction for fees or expenses.

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.

This document may contain forward-looking statements relating to the objectives, opportunities and future performance of the US and global markets generally. Forward-looking statements may be identified by the use of such words as: “expect,” “estimated,” “potential” and other similar terms. Examples of forward-looking statements include, but are not limited to, estimates with respect to financial condition, results of operations, and success or lack of success of any particular investment strategy. All are subject to various factors, including, but not limited to, general and local economic conditions, changing levels of competition within certain industries and markets, changes in interest rates, changes in legislation or regulation, and other economic, competitive, governmental, regulatory and technological factors affecting a portfolio’s operations that could cause actual results to differ materially from projected results. Such statements are forward-looking in nature and involve a number of known and unknown risks, uncertainties and other factors, and accordingly, actual results may differ materially from those reflected or contemplated in such forward-looking statements. In addition, certain information upon which assumptions have been made has been provided by third-party sources and, although believed to be reliable, the information has not been independently verified and its accuracy or completeness cannot be guaranteed. Prospective investors are cautioned not to place undue reliance on any forward-looking statements or examples. None of City National Rochdale nor any of its affiliates or principals nor any other individual or entity assumes any obligation to update any forward-looking statements as a result of new information, subsequent events or any other circumstances. All statements made herein speak only as of the date that they were made.

This information is not intended as a recommendation to invest in a particular asset class, strategy or product.

The information presented is for illustrative purposes only and based on various assumptions which may not be realized. No representation or warranty is made as to the reasonableness of the assumptions made or that all assumptions used have been stated or fully considered.

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.

Gross Domestic Product (GDP) is the total monetary or market value of all the finished goods and services produced within a country’s borders in a specific time period.

The Consumer Price Index (CPI) measures the monthly change in prices paid by US consumers.

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.

CNR is free from any political affiliation and does not support any political party or group over another.

City National Rochdale, LLC, is a SEC-registered investment adviser and wholly owned subsidiary of City National Bank. Registration as an investment adviser does not imply any level of skill or expertise. City National Bank and City National Rochdale are subsidiaries of Royal Bank of Canada. City National Bank provides investment management services through its subadvisory relationship with City National Rochdale, LLC.

Quality Ranking: City National Rochdale Proprietary Quality Ranking is the weighted average sum of securities held in the strategy versus the S&P 500 at the sector level using the below formula.

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.

4P analysis:The 4P analysis is a proprietary framework for global equity allocation. Country rankings are derived from a subjective metrics system that combines the economic data for such countries with other factors including fiscal policies, demographics, innovative growth and corporate growth. These rankings are subjective and may be derived from data that contain inherent limitations.


Index Definitions

S&P 500 Index. The Standard & Poor’s 500 Index is a market capitalization-weighted index of 500 common stocks chosen for market size, liquidity, and industry group representation to represent US equity performance.

Russell 2000® Index. The Russell 2000® Index is a market capitalization-weighted index measuring the performance of the small-cap segment of the US equity universe and includes the smallest 2,000 companies in the Russell 3000® Index.

DJ US Select Dividend Index®. The Dow Jones US Select Dividend Index® measures the performance of the top 100 US stocks by dividend yield.

MSCI EAFE Index. 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.

MSCI EM Index. 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.

Bloomberg US Aggregate Bond Index. The Bloomberg US Aggregate Bond Index measures the performance of investment grade, US dollar-denominated, fixed-rate taxable bonds.

Bloomberg US Investment Grade Corporate Bond 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 US Corporate 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 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.

Bloomberg US Corporate 1-5 years Total Return Index Value Unhedged USD:

Citi Economic Surprise Index:The Citigroup Economic Surprise Indices are objective and quantitative measures of economic news. They are defined as weighted historical standard deviations of data surprises (actual releases vs Bloomberg survey median).

Bloomberg US Corporate High Yield Total Return Index Value Unhedged USD 1-5y. Bloomberg US 1-15 Yr. Municipal Bond Index consists of a broad selection of investment grade general obligation and revenue bonds of maturities ranging from one year to 17 years.

Palmer Square BB CLO Index. Palmer Square CLO BB Index  is a rules-based observable pricing and total return index for CLO debt sold the United States, rated A, BBB or BB (or equivalent rating), i.e. mezzanine CLO debt.

Morningstar LSTA Leveraged Loan Index. Morningstar LSTA US Leveraged Loan Index is designed to measure the performance of the 100 largest facilities in the US leveraged loan market.

 Bloomberg High Yield. The Bloomberg Barclays U.S. Corporate High Yield Index measures the market of USD-denominated, non-investment grade, fixed-rate, taxable corporate bonds.

Bloomberg Investment Grade Municipal Index. Bloomberg Municipal Index The Bloomberg Municipal Index measures the performance of the Bloomberg U.S. Municipal bond market, which covers the USD- denominated Long-Term tax-exempt bond market with four main sectors: state and local general obligation bonds, revenue bonds, insured bonds, and pre-refunded bonds.

Indexes are unmanaged and do not reflect a deduction for fees or expenses. Investors cannot invest directly in an index.



Commercial and Industrial (C&I) Loan: A commercial and industrial (C&I) loan is a loan made to a business or corporation. 



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