Economic Perspectives: Federal Debt: A Fiscal Year End Update
FAQs on the Markets and Economy
Has CNR’s Outlook for Stocks Changed?
Investors are increasingly concerned about the risk of a recession as the U.S. stock market enters a bear market and the Fed’s fight against inflation intensifies.
Regarding the outlook for the economy, we see both positives and negatives: U.S. fundamentals, especially those for households, are still broad and powerful and should provide some cushioning against rising headwinds. Conversely, inflation is more sustained than originally estimated and geopolitical uncertainty is increasing, slowing economic momentum and reducing consumer and corporate confidence from 30% to 50% in 2023. Executing a soft landing is difficult under the best of circumstances, and Fed officials have no standard playbook for the multitude of uncertainties that exist around today’s outlook, raising the possibility of a policy mistake.
As risks have increased over the past few months, we have been proactively lowering our overall equity exposure in client portfolios and are now at a modest underweight. Although the S&P 500 has corrected roughly 20% so far, recessionary bear markets have historically declined 30-35% on average, suggesting further declines in stock prices are possible in coming months. Despite valuation adjustments, consensus earnings estimates have not yet discounted an increasing risk of an economic downturn.
Before a more durable bottom in markets is reached, we think investors will need better clarity on the path of inflation and Fed tightening, as well as the outlook for sustainable economic and earnings growth. In the meantime, we remain focused on holding high-quality, reasonably valued U.S. companies with durable franchises and strong management teams to help weather a recession should one occur.
Yields and Inflation: A Rough Rule of Thumb?
Over the past 20 years, interest rates have only been this volatile three times before today, according to the MOVE Index – a measure of implied volatility in U.S. Treasury options.
In environments like this, emotions run high, and fear grips the market. As investors, what can we do to look through the volatility and gauge longer-term results, especially when it comes to rates?
Inflation hasn’t been around in 50 years, which means we need to break out old tools to understand how rates might behave and what the longer-term 10-year Treasury yield could average over the next 10 years. In that pursuit, we use a simple calculation to adjust yields for inflation and analyze this historically. Over 20 years, for pre-and post-quantitative easing as a policy tool, the average is about 1.4%. Compared to today’s 0.70% level, the market is only half of the long-run average. There are two ways this number can increase. The first is from rising Treasury yields and the second is from falling long-term inflation expectations. Amazingly, longer-run inflation expectations have remained incredibly well anchored, with 10-year expectations only moving up 0.26%. As a result, most of the increase over time will come from rising Treasury yields.
This doesn’t mean the market will not overshoot the long-term average or stay lower for longer, but by using this as an anchoring point, we should expect Treasury yields to eventually reach 4% beyond 2022, which is also consistent with the Federal Reserve’s long-run estimates.
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 infor-mation. Certain information has been provided by third-party sources, and although believed to be reliable, it has not been inde-pendently 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.
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 in-vestments in longer-duration fixed income securities and during periods when prevailing interest rates are low or negative.
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.
This material is available to advisory and sub-advised clients, as well as financial professionals working with City National Rochdale, a registered investment advisor and a wholly-owned subsidiary of City National Bank. City National Bank provides investment management services through its sub-advisory relationship with City National Rochdale.
Non Deposit Investment Products are: Not FDIC Insured, Not Bank Guaranteed, May Lose Value
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. Readers are cautioned that such forward-looking statements are not a guarantee of future results, involve risks and uncertainties, and actual results may differ materially from those statement. 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.
Past performance or performance based upon assumptions is no guarantee of future results.
Indices are unmanaged and one cannot invest directly in an index. Index returns do not reflect a deduction for fees or expenses.
Any opinions, projections, forecasts, and forward-looking statements presented herein are valid as on the date of this document and are subject to change.
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 does not ensure a profit or protect against a loss in a declining market. Past performance is no guarantee of future performance.
This material is available to advisory and sub-advised clients, as well as financial professionals working with City National Rochdale, a registered investment adviser and a wholly-owned subsidiary of City National Bank. City National Bank provides investment management services through its sub-advisory relationship with City National Rochdale.
INDEX DEFINITIONS
S&P 500 Index: The S&P 500 Index, or Standard & Poor’s 500 Index, is a market-capitalization-weighted index of 500 leading pub-licly traded companies in the U.S. It is not an exact list of the top 500 U.S. companies by market cap because there are other criteria that the index includes.
Muni Bond: A municipal bond is a debt security issued by a state, municipality or county to finance its capital expenditures, includ-ing the construction of highways, bridges or schools. These bonds can be thought of as loans that investors make to local govern-ments.
Bloomberg Barclays U.S. Corporate High Yield Bond Index: measures the USD denominated, high-yield, fixed-rate corporate bond market.
Dow Jones Select Dividend Index: The Dow Jones U.S. Select Dividend Index looks to target 100 dividend-paying stocks screened for factors that include the dividend growth rate, the dividend payout ratio and the trading volume. The components are then weighted by the dividend yield.
The SIFMA Municipal Swap Index: The Securities Industry and Financial Markets Association Municipal Swap Index is a 7-day high-grade market index comprised of tax-exempt Variable Rate Demand Obli-gations (VRDOs) with certain characteristics. The Index is calculated and published by Bloomberg. The Index is overseen by SIFMA’s Municipal Swap Index Committee.
CalPERS: The California Public Employees’ Retirement System, also known as CalPERS, is an organization that provides numerous benefits to its 2 million members, of which 38% are school members, 31% public agency members, and 31% state members.
4Ps: 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.
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