May 2023 Market Update:

A Deep Dive into CNR’s Economic and Investment Outlook

 

May 24, 2023



 
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Inflation, Interest Rates & Market Volatility Remain Focus as Debt Ceiling Woes Subside

This is a recap of the May 24th webinar only, and may not reflect recent developments and our analysis.

 

The probability of a recession has increased to 78%, according to City National Rochdale. Our team now predicts a mild recession unfolding over the second half of 2023, despite the debt ceiling issue being resolved by Congress and the White House for the near term.

Other issues impacting investment strategies, according to CNR, include the ongoing push to reduce inflation, credit tightening, higher interest rates and geopolitical risk.

Banking Sector Strength

Despite the failure of several banks, the banking industry is still healthy and in overall good shape, said Tom Galvin said, CNR's chief investment officer. Most banks are well capitalized and he does not expect a repeat of the Great Financial Crisis.

The main impact to the broader economy will likely come from tightening credit conditions. Banks are becoming more conservative and trying to shore up their balance sheets, which will constrain borrowing.

 

Recent Financial Stresses Easing

St. Louis Federal Reserve Bank Financial Stress Index
10-Year History, weekly
cnb article 1

Source: St. Louis Federal Reserve, Bloomberg, CNR Research. As of 5/19/2023.

Information is subject to change and is not a guarantee of future results.

On a positive note, much of the financial stress that has put pressure on markets has eased in recent weeks, said Charles Luke, co-director of fixed income and CNR managing director.

 

The key indicator that is causing the most concern and fear in the market is rate volatility.

While CNR continues to predict a mild recession in the latter half of 2023 and core services inflation remains sticky, some inflation on housing and goods is easing.

Wage Growth
(% Change Y/Y)
cnb article 2

Source: Bureau of Labor Statistics, as of March 2023.

The bigger challenge is wage growth, which the Fed continues to need to tamp down. However, wage growth has eased in recent months and, if it continues to decline, inflation should become less of a headwind for the economy and markets by the end of the year, Galvin said.

 

Inflation Remains Central Issue

Change in M2 Money Supply - YoY % Change
cnb article 3.1

Source: Bloomberg, CNR Research. As of 5/19/2023.

Information is subject to change and is not a guarantee of future results.

CNR continues to anticipate that the Fed will keep rates higher for longer and does not expect any rate cuts this year as some other analysts believe.

Federal Reserve Balance Sheet
cnb article 3.2

Source: Bloomberg, CNR Research. As of 5/19/2023.

Information is subject to change and is not a guarantee of future results.

 

The U.S. money supply is contracting for the first time since quantitative easing began, which is likely to impact liquidity. Typically, a shrinking money supply precedes a recession, which provides another recessionary signal, Luke said.

Yield Curve 50 Day Moving Average
(10-Year Treasury Minus 3-Month Treasury)
cnb article 4

Sources: FactSet, CNR Research, as of March 2023. 

Information is subject to change and is not a guarantee of future results.

 

 

The inversion of the 10-Year/3-Month Treasury yield curve has also consistently preceded every U.S. recession, with a recession beginning within an average of 12 months of the first day of the inversion.

However, inflation is higher, consumer balance sheets are healthy, and the job market is healthy, all of which indicates that the inversion rate could pivot. Still, odds for a mild or normal recession before year's end are 78%, Luke said.

cnb article 5

Source: Proprietary opinions based on CNR Research, as of May 2023. 

Information is subject to change and is not a guarantee of future results.

The Current Economic Outlook

 

CNR Speedometers®, which are forward-looking indicators for the next six to nine months, are all yellow (neutral) or red (negative) this month.

The headwinds are credit availability, monetary policy, geopolitical risk and slowing GDP, Galvin said. But expectations of easing inflation should help improve real disposable income and consumer confidence.

“Inflation is public enemy No. 1 in terms of consumer confidence," he said.

YTD Performance
(As of 5/22/23)
cnb article 6

Source: FactSet, as of May 2023.

7 Tech Titans are: Alphabet, Amazon, Apple, Meta Platforms, Microsoft Nvidia, Tesla.

Past performance is no guarantee of future results.

Macro uncertainty in the economy supports CNR's continued defensive economic strategy, which remains modestly underweight on equities, modestly overweight on fixed income and focused on high-quality U.S. stocks and bonds.

 

The recent market rally may not be sustainable because a handful of stocks — mostly the tech titans — have kept returns up above 9%, Galvin said. Meanwhile, the broader equity universe struggled to post positive returns.

Investment Adjustments During Volatility

CNR's strategy continues to focus on high quality companies with less cyclicality, Galvin said.

CNR Quality Ranking
cnb article 7.1

Sources: FactSet, CNR Research as of May 2023.

Information is subject to change and is not a guarantee of future results. City National Rochdale Proprietary Quality Ranking is the weighted average sum of securities held in the strategy versus the S&P500 at the sector level using the formula described below. 

 

Cyclical Exposure
cnb article 7.2

Sources: FactSet, CNR Research as of May 2023.

Information is subject to change and is not a guarantee of future results. City National Rochdale Proprietary Quality Ranking is the weighted average sum of securities held in the strategy versus the S&P500 at the sector level using the formula described below. 

 

“We're looking for the right blend of defense against a potential recession and an offensive game plan for the post-recession," Galvin said.

CNR believes that for most investors it's not time yet to add exposure to longer maturity bonds since they remain volatile. However, longer maturity bonds are likely to be more attractive during the second half of 2023, Luke said.

Credit Standards vs. Global High Yield Default Rate
cnb article 8.1

SLOOS: The Senior Loan Officer Opinion Survey on Bank Lending Practices (SLOOS) is a quarterly survey of up to 80 large domestic banks and 24 branches of international banks.

Source: SIFMA, as of April 2023.

Information is subject to change and is not a guarantee of future results. 

US High Yield Spread
cnb article 8.2

SLOOS: The Senior Loan Officer Opinion Survey on Bank Lending Practices (SLOOS) is a quarterly survey of up to 80 large domestic banks and 24 branches of international banks.

Source: SIFMA, as of April 2023.

Information is subject to change and is not a guarantee of future results. 

For now, shorter term bonds provide income and benefit from the higher federal funds rate. However, for new portfolios, longer term bonds still make sense as part of the investment mix.

 

 

Tightening lending standards typically lead to an increase in default rates, so there's potential for more defaults in the coming months. The peak default rate is about 5% to 6%, but even with the pressure of tighter standards, yields are more than enough to offset this for now. Yields above 8% have driven returns and limited volatility so far and CNR projects high yield bond interest rates to peak around 10%, a level 5.8% above U.S. Treasuries.

However, more cautious investors may want to shift away from high yield bonds if more defaults appear on the horizon.

Municipal bonds in many cases are yielding more than taxable asset classes for the first time in 2023. The municipal bonds market is supported by the dynamics of demand against limited supply, which is a tailwind to the market and a major reason for the relative outperformance to corporate bonds since rates reached over 4.2% last year.

Based on your specific tax bracket and needs, you may want to talk with your portfolio manager about the balance between taxable and tax-exempt investments.

 

City National Rochdale Continues to Monitor Volatility 

High Quality Municipal vs. Treasury Ratios
cnb article 9

Source: Bloomberg, as of 5.8.2023.

Information is subject to change and is not a guarantee of future result.

CNR's investment committee continues to evaluate a variety of factors that could impact portfolios. The major issues this month include the continued higher for longer thesis about interest rates and the continuing elevated risk of a mild recession.

 

CNR forecasts moderate equity returns for 2023 and above average volatility, which makes an equity income strategy attractive. Investment grade corporate and municipal bonds offer healthy yields with lower volatility, while high yield corporate and municipal bonds offer reasonable reward in exchange for the risk of more volatility.

Important Information

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. objectives will be met, and investors may lose money. Diversification may not protect against market risk or loss. 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.

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.

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

CNR Speedometers® are indicators that reflect forecasts of a 6 to 9 month time horizon. The colors of each indicator, as well as the direction of the arrows represent our positive/negative/neutral view for each indicator. Thus, arrows directed towards the (+) sign represents a positive view which in turn makes it green. Arrows directed towards the (-) sign represents a negative view which in turn makes it red. Arrows that land in the middle of the indicator, in line with the (0), represents a neutral view which in turn makes it yellow. All of these indicators combined affect City National Rochdale’s overall outlook of the economy.

Quality Ranking: City National Rochdale Proprietary Quality Ranking is the weighted average sum of securities held in the strategy versus the S&P500 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.

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 subadvisor relationship with City National Rochdale, LLC.

 

Non-deposit investment Products are: • not FDIC insured • not Bank guaranteed • may lose value

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