October 2023 Market Update

Market Update Summary

Investing in Uncertain Times

Heightened geopolitical tensions and political bickering in the nation's capital are creating an atmosphere of uncertainty for investors but our leadership team at City National Rochdale, continues to have confidence in our economic outlook and investment strategy. No major changes were announced during our October 2023 Market Update. In fact, the 2023 GDP outlook is turning out better than previously anticipated because of the resilience of labor markets and households, according to Tom Galvin, chief investment officer for City National Rochdale.

 

 

Inflation continues its downward glidepath and the Fed is likely to be near the end of its rate hikes, but interest rates are still anticipated to remain higher for longer, Galvin said.

The U.S. economic outlook is more resilient than economies in Europe and Asia.

“Geopolitical tension is the highest risk to our economic forecast,” Galvin said. “However, the volatility we're seeing may offer a buying opportunity for blue chip U.S. stocks.”

We have greater confidence in the path forward, with a higher expectation of slow growth or a soft landing and a lower expectation of a mild recession, he said. Earnings growth in 2024 is anticipated to follow the pace of the economy with a recovery during the second half of the year.

 

The higher for longer thesis we introduced in Spring 2022 holds today, particularly because of the potential impact of geopolitical tension including the conflict in the Middle East.

Geopolitical tension can affect the economy in two ways has two potential impacts. One is the possibility of additional exogenous events of sufficient scale to disrupt the economy. The other is the deficit spending in the U.S. and other economies to shift to industrial and military spending, which puts pressure on interest rates, Galvin said.

 

One of the CNR Speedometers, which are forward-looking economic indicators of six to nine months, tilted more negative compared to last month: geopolitical risk. The concern is that the global economy is realigning into U.S. and China blocs, which in turn influences corporate investment decisions and industrial policies.

 

Multiple geopolitical risks may have an impact on the U.S. economy and global markets. Among them is the upcoming January 2024 election in Taiwan, which is important because of ongoing tensions with China, Galvin said. Taiwan manufactures 80% of the world's complex chips, and 70% of global shipping passes through Taiwan.

Escalation of tensions in the Middle East is possible, although global entanglement in the conflict is unlikely, Galvin said.

 

“All of this uncertainty supports our modestly defensive investment stance,” Galvin said.

 

Previous global political conflicts, particularly in the Middle East, had a direct impact on the U.S. because of our dependence on oil, said Paul Single, managing director, senior economist and senior portfolio manager for City National Rochdale. Now, the U.S. depends on about one-third as much oil.

 

Single said that natural gas dependence is similarly lower. Consumers spend less of their money on energy because of cars getting better gas mileage, hybrid cars and EVs, and homes built with better insulation and windows.

 

Markets tend to be resilient to domestic and global events as long as fundamentals in the economy are strong, Galvin said.

“The silver lining is that there's usually a flight to safety during geopolitical shocks, which means higher demand for U.S. bonds and a stronger dollar,” Galvin said.

 

Partisan bickering increases the risk of a government shutdown. However, the typical shutdown of 15 to 30 days has less than 0.3% impact on the S&P 500, Galvin said. A modest impact could offer a buying opportunity.

 

The Goldman Sachs Financial Conditions Index looks at a variety of data to generate a single number indicating the health of the economy. The U.S. economy has been moving forward well despite higher rates and geopolitical uncertainty because of the strong labor market and household savings. However, a slowdown is expected over the next few quarters since households have largely spent down their extra savings.

 

Investing during periods of uncertainty offers some opportunities, but it also remains prudent to favor U.S. equities, Galvin said. CNR's “4Ps Framework” for investing continues to demonstrate the advantages of investing in the U.S., as does the performance of the S&P 500.

The 4Ps refer to CNR's allocation approach for investing in equities in different regions of the world, which is based on reviewing policies that enhance growth, population (including productivity and demographic trends), potential for innovation such as technology, and profitability. The U.S. is the clear winner globally in most of those categories, Galvin said.

 

People typically spend 90% of what they make, Single said. The trendline in recent months is a return to pre-pandemic spending levels, but some of the tailwinds that helped people spend more during the pandemic are now headwinds. Wage growth has slowed, the lack of stimulus checks and the reduction in household balance sheets of excess savings are anticipated to lead to a drop-off in consumer spending.

In addition, reduced access to credit and higher interest rates will contribute to slower spending.

 

Multiple indicators demonstrate that wage gains are moderating, which Fed Chair Jerome Powell points to as signs that higher interest rates are having their desired effect to bring down inflation. This supports our higher for longer thesis, Single said.

 

CNR continues to be modestly defensive in its asset allocation, with a reduced exposure to cyclical stocks and an emphasis on high quality U.S. stocks with lower risks.

“We're reluctant to signal the all-clear,” Galvin said. “We've seen no confirmation that we've hit the true low so far.”

Small cap stocks, which are more sensitive to the business cycle tend to perform better than large cap stocks, but that's not happening yet, he said.

 

The recent rise in bond yields has created some uncertainty and concern for investors. Some of the reasons for higher yields include the better-than-expected economic news, concern about the outcome of federal tightening and geopolitical influences, Galvin said.

The volatility in short term bonds is not normal, but this could be a buying opportunity for bonds of above average quality and below average duration over the next year or so, Galvin said.

 

We use the economic outlook and strategies developed by the Rochdale team to implement a goals-based investing approach and build client portfolios, said Rachel Crane, a senior portfolio manager with City National Rochdale.

“Each portfolio has a personalized benchmark rooted in financial planning that includes a timeline and risk tolerance,” Crane said. “We take into account both growth and income needs. We focus on capital preservation and getting the best after-tax returns in individualized portfolios."

In every case, the portfolio starts with a base of personal goals and then changes are made individually based on CNR’s research, she said.

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