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Interest Rates & Mild Recession to Impact 2023 Markets
After a strong start to 2023, market volatility returned in February, according to City National Rochdale, City National Bank's investment advisory organization. There could be additional declines in the near term before conditions for a more sustainable rally in stock prices fall into place over the second half of the year. Investment leaders from Rochdale provided their most recent outlook during their February 2023 market update.
While the recent strength in economic activity is a positive development, the Rochdale team is only moderately revising their overall risk of a recession in 2023 from 75% down to 70%. A mild recession is anticipated to start in the second or third quarter of 2023.
“The incoming economic data we're seeing supports our higher-for-longer thesis," said Tom Galvin, chief investment officer for City National Rochdale. “In addition, leading indexes, the inverted yield curve, tightening lending standards and declining manufacturing support our recession view, while encouraging signs of disinflation, a healthy job market, wage gains, savings and net worth support the outlook for a mild recession."
Rochdale is staying the course with modestly defensive positioning and is overweight to fixed income, Galvin said.
“While history suggests we're coming to the end of this cyclical bear market in stocks, we believe it's too soon to signal the all clear," Galvin said.
Rochdale Speedometer Updates
Rochdale's Speedometers®, which are forward-looking indicators for the next six to nine months, showed modest changes this month but continue to signal a slow growth to mild recessionary outlook.
The U.S. and global economic dials marginally improved, while equity market valuation and credit availability turned more negative. The biggest change was with the housing dial turning to neutral from negative. The housing market continues to face considerable challenges, but the dial improvement reflects anticipation that a bottoming process will begin in the quarters ahead making the sector less of a headwind to economic activity.
Rochdale's updated forecast shows that the probability of a normal recession fell from 15% to 5%, while the probability of a mild recession increased to 65%, and the probability of a slow growth economy increased to 30%.
Given the stronger than expected economic data so far this year, 2023 GDP is anticipated to be modestly higher than previous forecasts, and Rochdale modestly increased its year-end inflation forecast. The expectation is that inflation will continue on its downward glidepath, but it will likely be choppy.
Unemployment Decreasing Despite Slow Economy
While economic momentum is slowing, the labor market continues to show resilience. There are approximately 11 million job openings, with about half that number (5.7 million people) looking for jobs.
“Layoffs in major companies, especially big tech companies, are headline grabbers because the media is profit-motivated, and that gets attention," said Paul Single, managing director, senior economist and senior portfolio manager for City National Rochdale.
Despite these headlines, Single maintained that worker shortages remain extreme.
Pandemic Still Causing Imbalances in Job Market
Partly, the problem is that pandemic imbalances are still playing a role in the labor market, Single said. The industries with the highest number of job openings, including leisure and hospitality and healthcare, are those where workers left during the pandemic due to a lack of work or to burnout.
In addition, the strongest demand for workers comes from small businesses with less than 250 employees, a trend that increased during the pandemic. Given ongoing labor shortages, these firms are more likely to retain workers rather than risk not being able to fill positions once economic prospects improve.
Fed Still Likely to Keep Rates Higher, Disinflation Trend Waning
The Federal Reserve Board is likely to keep rates higher for longer and more tightening is anticipated, Single said.
Inflation, especially for labor-intensive services and shelter costs, is proving stickier than previously thought and disinflation is waning.
“The pace of slowing is slowing," Single said.
Shelter inflation, which is based on rents, should start coming down by the summer.
However, the Fed continues to focus on wage growth and is paying close attention to core services inflation excluding shelter. That measure of inflation has slowed, but the progress is likely not enough to keep the Fed from keeping rates high.
For inflation to return to the target rate, the Fed believes that the yearly change in average hourly earnings needs to be in the 2.5% to 3.5% range.
The Federal Deficit & Debt Could Cause Market Volatility
The U.S. government officially exceeded its debt limit of $31.4 trillion in January, forcing the Treasury Department to begin “extraordinary measures" to ensure the government meets its obligations.
“The U.S. Treasury won't default on the debt," Single said.
There is historic precedent for Congress to come together on a deal at the last minute during previous debt ceiling standoffs. Rochdale continues to closely watch developments to assess the risk to the economy and to financial markets. The debt standoff could be another source of volatility for financial markets in the coming months, Single said.
Is Recent International Equities Outperformance Sustainable?
International stocks were overdue for a bounce after underperforming through the first nine months of 2022, said Galvin, but it's not expected to last over the long-term.
Among the reasons for the outperformance was the perception that valuations were cheap, that the European economy was not in as bad shape as was feared and optimism about China's reopening.
Rochdale believes the recent outperformance in international equities is unsustainable and continues to maintain its position that the U.S. outlook remains the most resilient for investors and best positioned for long-term growth.
Rochdale's recommendation to remain underweight on China is based on continued geopolitical risk such as trade tensions with the U.S. and support for Russia, as well as questions about a property bubble in China.
In Europe, there's no end in sight to the Ukraine war and the European Central Bank is behind the curve on inflation, with more rate hikes anticipated, Galvin said. In the long-term, there are structural challenges in Europe due to demographics and immigration, along with a lack of corporate representation in growing segments of the global economy such as information technology.
For Rochdale's position on international equities to change, it would need to see an end to the war in Ukraine and a reversal of authoritarian trends in China among other developments.
The Bear Market Looks to be Nearing Its End
While the bear market isn't over, the good news is that it's likely closer to the end, Galvin said. However, in the near term, the market appears to have gotten ahead of the fundamentals. Earnings revisions and a higher-for-longer Fed could be the catalysts for further volatility and additional stock declines in the months ahead.
Moderating inflation data and anticipation that the Fed would begin to cut rates as soon as this year have partially driven the recent rally. In addition, optimism about global GDP improvements and a revival in tech stocks – driven by the hype around AI advancements – contributed to stock gains.
Historically, no recessionary bear market has ended before a recession begins and Rochdale believes the market is still pricing in a soft landing for the economy with positive 2023 earnings growth. Rochdale forecasts a decline in 2023 earnings of 2.5% on a weighted average perspective and 5% in its mild recession scenario, but a decline of up to -10% isn't out of the question.
Signs of the Bear Market's End to Watch For
Events and signals that Rochdale is watching to confirm that this cyclical bear market is ending include the Fed pausing rate increases, headline inflation falling below wage growth, a bottoming in economic activity and upward earnings revisions.
Rochdale is prepared to reallocate investments depending on whether the fundamentals fall into place, which could mean shifting from a modestly defensive posture to a more neutral stance. More than likely, that would mean adding cyclical equity exposure in the U.S. and trimming fixed income investments.
However, the investment team has strategies in place to address a worst-case scenario if the market turns into a secular bear market rather than a cyclical one.
For now, Rochdale is staying the course. For planning purposes they estimate 5% to 7% total returns for balanced portfolios, with fixed income likely to lead the way with lower volatility. More sustainable stock advances are anticipated in the second half of the year.
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City National Bank provides investment management services through its wholly owned subsidiary City National Rochdale, LLC, a registered investment advisor. Content from the January 25, 2023 presentation, "Market Update" is reprinted by permission from City National Rochdale.
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.
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.
Any opinions, projections, forecasts, and forward-looking statements presented herein are valid as on the date of this document and are subject to change.
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.
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. All investing is subject to risk, including the possible loss of the money you invest.
Returns include the reinvestment of interest and dividends.
Indexes are unmanaged and investors are not able to invest directly into any index.
The mention of a specific security is not a recommendation to buy, or solicitation to sell such security.
S&P 500 Index: The S&P 500 Index, or Standard & Poor’s 500 Index, is a market-capitalization-weighted index of 500 leading publicly 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, including the construction of highways, bridges or schools. These bonds can be thought of as loans that investors make to local governments.
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 Intercontinental Exchange (ICE): The Intercontinental Exchange (ICE) is an American company that owns and operates financial and commodity marketplaces and exchanges.
The Bloomberg Aggregate Bond Index: "the Agg" is a broad-based fixed-income index used by bond traders and the managers of mutual funds and exchange-traded funds (ETFs) as a benchmark to measure their relative performance.
U.S. Treasury Yield Curve: refers to a line chart that depicts the yields of short-term Treasury bills compared to the yields of long-term Treasury notes and bonds.
Consumer Price Index (CPI): is a measure that examines the weighted average of prices of a basket of consumer goods and services, such as transportation, food, and medical care.
Bloomberg Barclays US Aggregate Bond Index: The Bloomberg Aggregate Bond Index or "the Agg" is a broad-based fixed-income index used by bond traders and the managers of mutual funds and exchange-traded funds (ETFs) as a benchmark to measure their relative performance.
MSCI Emerging Asia PE: The MSCI Emerging Markets Index is a selection of stocks that is designed to track the financial performance of key companies in fast-growing nations. It is one of a number of indexes created by MSCI Inc., formerly Morgan Stanley Capital International.
Global Equity Markets: a global market in which shares of companies are issued and traded, either through exchanges or over-the-counter markets.
Diffusion Index: Used in technical analysis, a diffusion index measures the number of stocks that have advanced in price or are showing positive momentum. It is useful for determining the underlying strength of the stock market overall, as lots of stocks advancing show a strong market, while few(er) stocks advancing show a weaker market. In the stock market, the diffusion index is usually measured from day to day. Advancing stocks are those that moved up from the prior closing price.
6M T-Bills: The 6 Month Treasury Bill Rate is the yield received for investing in a US government issued treasury bill that has a maturity of 6 months.
2-Year Treasury Notes: negotiable debt obligations issued by the U.S. Treasury Department (other than a Stripped Treasury Security) having a remaining maturity of more than one year but not more than two years.
Liquidity Management: The liquidity index calculates the days required to convert a company's trade receivables and inventory into cash.
Investment Grade Municipal Bonds: Investment-Grade Municipal Bond Investment-grade municipal bonds are debt securities, issued by state and local governments carrying the lowest credit risk that a bond issuer may default. Investment Grade Municipal Bonds: Bloomberg Municipal Bond Inter-Short 1-10 Year Total Return Index.
Investment Grade Corporate Bonds: Investment grade corporate bonds are low-risk bonds. Because they are bonds, they are not tied to equity. Instead, they are like debt notes issued by a corporation. Investment Grade Corporate Bonds: Bloomberg Intermediate Corporate Bond Index.
High Yield Corporate Bonds: “U.S. High Yield Corporate” is represented using the U.S. High Yield Index.
High Yield Municipal Bonds: Bloomberg 60% Tax-Exempt HY / 40% LB Municipal Investment Grade Total Return Index.
Leveraged Loans: S&P LSTA Leveraged Loan Index, 6m T-Bills – ICE BofA 6-Month Treasury Bill Index, U.S. High Yield Corporate: 1-3 Years – ICE BofA
U.S. High Yield 1-3 Year Index, Intermediate Municipal – Bloomberg 1-15 Yr Municipal Index, U.S. High Yield Corporate – Bloomberg U.S. High Yield Corporate Index, Intermediate IG Corporate – Bloomberg Intermediate Corporate Index, High Yield Municipal – Bloomberg 60% Tax-Exempt HY/40% LB Municipal Index.
Speculative Technology: Companies in early stages of business development with negative net income that provide technology products or services.
Digital Revolution: Companies that provide technology products or services, and/or use technology products and services in a manner that enhances their business.
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.
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.
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 that 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.
This document may contain forward-looking statements relating to the objectives, opportunities and the future performance of the U.S. market 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. Prospective investors are cautioned not to place undue reliance on any forward-looking statements or examples.
None of City National Rochdale or 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.
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.
References to indexes and benchmarks in hypothetical illustrations of aggregate returns do not reflect the performance of any actual investment. Investors cannot invest in an index, and such returns do not reflect the deduction of the advisor's fees or other trading expenses. There can be no assurance that current investments will be profitable. Actual realized returns will depend on, among other factors, the value of assets and market conditions at the time of disposition, any related transaction costs and the timing of the purchase. Indexes and benchmarks may not directly correlate or only partially relate to portfolios, as they have different underlying investments and may use different strategies or have different objectives than our strategies or funds.
CNR is free from any political affiliation and does not support any political party or group over another.
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