City National Bank investment leaders maintain their optimistic view on the U.S. economy for 2022 and beyond, anticipating that growth will slow next year but exceed long-term trends.
The team at City National Rochdale, the bank's investment advisory organization, also expects more modest returns across asset classes in 2022, with higher volatility early in the year. In a Dec. 15 update, they said those market swings should present investment opportunities.
The team continues to overweight client portfolios toward risk assets — U.S. stocks, emerging market Asia equities, taxable and tax-exempt opportunistic income such as high-yield debt, and alternative investments including collateralized loan obligations, direct lending and capital leasing.
Given ongoing low interest rates, the portfolios remain underweight in investment-grade bonds. The team remains committed to the notion that U.S. small-, mid- and large-cap equities and income-producing stocks will continue to outperform equities from other developed nations. Given high stock valuations, they also anticipate that average annual returns will be more muted for several years.
The team delivered its forecast the same day that the U.S. Federal Reserve signaled it will moderate the economic supports implemented during the coronavirus pandemic. The plan includes speeding the tapering of its massive, historically high asset purchase program as well as raising interest rates potentially three times next year.
City National Rochdale leaders had anticipated the Fed's announcement, given the economy's current above-trend growth and unexpectedly high inflation. They said that while congressional and Fed policy support will diminish, it will continue to help the economy.
Consumer and corporate financial fundamentals are healthy, and pandemic-related pressures such as inflation, wage increases, supply chain bottlenecks and goods and labor shortages should subside next year, according to the investment team.
"We see a vibrant and roaring economy in the next few years," driven chiefly by employment, said Paul Single, City National Rochdale senior economist and senior portfolio manager.
About 80% of the jobs lost during the pandemic have returned, he said. Single noted that, following previous recessions, the country was grappling with rising unemployment.
Based partly on data from the Bureau of Economic Analysis, the firm forecasts 3.5% to 4.5% gross domestic product growth in 2022. That compares with this year's anticipated 5.25% to 6% GDP expansion, which pandemic-related emergency economic supports have lifted from the government and Federal Reserve.
The government checks that buoyed consumers and businesses earlier in the pandemic and helped drive strong demand won't be coming in 2022, Single noted.
The team, revising its estimates upwards, expects corporate profits to grow by 7% to 17% next year, compared with 45% to 50% this year. City National Rochdale's "base case" is that growth in S&P 500 profits will slow to 12% in 2022, reflecting unexpectedly strong earnings this year.
Rochdale leaders also forecast modest increases in short-term interest rates next year. They have raised their Consumer Price Index inflation target for 2022, while expecting it to moderate throughout the year. Specifically, Rochdale projects 3% to 4% CPI growth in 2022, compared with 4.2% to 4.7% this year, and 0.5% to 1% increases in interest rates.
Supply chain issues that have driven inflation should see some resolution next year, placing downward pressure on prices, Single said, noting Bureau of Labor Statistics data showing a dramatic spike in the price of goods this year.
"There will eventually be a rebuilding of inventory levels when we get through these global supply chain issues," Chief Investment Officer Tom Galvin said. Inventory restocking bodes well for City National Rochdale's portfolio holdings, as do strong economic growth and rising interest rates, he said.
That rebuilding is vital to Rochdale's GDP calculation, Single said.
Rates for the 10-year Treasury note should rise slightly next year to a range of 1.7% to 2.2%, according to Rochdale team members, who noted that the fixed-income market and high-yield municipal bonds tend to perform well when the Fed raises interest rates. They don't anticipate the faster tapering to affect longer-term interest rates.
Galvin shared the team's 2021 report card, explaining that investment leaders were correct in their optimism about the economy, corporate profits and risk asset outperformance. The team also correctly predicted the path for interest rates.
They also got their portfolio weighting correct, favoring U.S. stocks over those from other developed countries, and riskier opportunistic income, high-yield municipal debt and alternative assets over investment-grade bonds — positions they're largely maintaining heading into 2022.
Galvin acknowledged the team missed the mark in some areas. Inflation was even higher than Rochdale's forecast, which itself surpassed the Wall Street consensus view. Emerging markets Asia lagged behind non-Asian emerging markets, and U.S. equities performed more strongly than expected while volatility was lower.
"Net-net, we are pleased with 2021," Galvin said. "We believe the multiyear economic expansion will continue."
Based on data from various market sources, the team expects EM Asia earnings to rebound in the second half of 2022 and continues to see the U.S. as better positioned than Europe for short-term recovery and long-term growth.
Galvin said that Rochdale considers its chosen equities less risky and higher quality than the S&P 500 overall in 2022, citing FactSet data. Margins should expand but more slowly than they did this year. Rochdale expects its holdings to outperform the broader market in an environment where lower investment returns are anticipated. "We see great upside potential for our stocks," he said.
Rochdale believes its income equities as well-positioned for the strong economy and higher interest rates. The team has meaningfully over-weighted real estate compared with the Dow Jones U.S. Select Dividend Index, while underweighting utilities, noted David Shapiro, senior equity analyst.
Citing various market sources, Shapiro said income stock yields look attractive compared with the S&P 500 and fixed-income investments. He expects 6% to 8% near-term total returns for high-dividend stocks.
Dividend growth should increase by 3.5% to 6.5% next year, in line with long-term expectations, with 3.5% to 4% yields, he said.
The team, citing Bloomberg data, reported that municipal bonds stood out this year, outperforming other fixed-income investments. State and local governments have benefited from higher revenue growth. Lower quality, high-yield bonds showed "dramatic outperformance" over higher quality, low-yield bonds, according to Michael Talia, co-director, fixed income at City National Rochdale.
Next year is "really shaping up to be similar to what we've seen this year," Talia added. Rochdale expects investment-grade municipal bond valuations to benefit from volatility in 2022 and issuer credit quality to improve, especially for airports, toll roads and certain hospital systems, he said.
According to Talia, demand for investment-grade muni bonds should remain strong. He expects low single-digit positive returns in the market in 2022.
William Black, Rochdale senior portfolio manager, municipal high-yield bonds, expects carefully selected bonds to remain attractive. High-yield bonds perform well when the Fed tightens interest rates, he said.
City National Rochdale is focused on adding better quality high-yield municipal bonds, especially in land-backed districts and multi-family housing, according to Black, who expects low single-digit returns that outpace investment grade municipal bonds by 1 to 2 percentage points.
Charles Luke, co-director, fixed income at City National Rochdale, expects stable rates in 2022, but said investors should be prepared to hear forecasts for high rates. He said that taxable government bonds and investment-grade corporate bonds would make for defensive assets but struggle to return more than 2%.
The firm expects opportunistic fixed income to outperform investment-grade fixed income and to return 3% to 5% next year, Luke said, citing various market sources.
Real returns in traditional fixed-income will be negative, while floating rate sectors such as leveraged loans and secured credit should outperform in 2022, Luke said.
The team expects alternative investments to remain strong and benefit from a rising-rate environment, with yields ranging from 5% to 10% and a potential for capital appreciation. Given core fixed-income yields near 1%, Rochdale favors high-yielding assets, said Thomas Ehrlein, director of investment solutions, citing various market sources.
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Investments in below-investment-grade debt securities which are usually called “high-yield” or “junk bonds,” are typically in weaker financial health and 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.
Investing in international markets carries risks such as currency fluctuation, regulatory risks, 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. Emerging markets can have greater custodial and operational risks, and less developed legal and accounting systems than developed markets.
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The S&P 500 Index is a market-capitalization-weighted index of the 500 largest publicly-traded companies in the U.S.
The Dow Jones U.S. Select Dividend Index aims to represent the U.S.’s leading stocks by dividend yield.
The Russell 2000 index measures the performance of the 2,000 smaller companies that are included in the Russell 3000 Index, which itself is made up of nearly all U.S. stocks.
The MSCI EAFE Index is a stock market index that is designed to measure the equity market performance of developed markets outside of the U.S. & Canada.
The MSCI Emerging Markets Asia Index is a free float-adjusted market capitalization index that is designed to measure equity market performance in the Asian emerging markets.
The MSCI Emerging Markets ex Asia Index captures large and mid cap representation across 17 Emerging Markets (EM) countries*. With 267 constituents, the index covers approximately 85% of the free float-adjusted market capitalization in each country excluding Asia.
The Bloomberg Barclays Aggregate Bond Index is an index used by bond traders, mutual funds, and ETFs as a benchmark to measure their relative performance.
The Bloomberg Barclays US Corporate High Yield Bond Index measures the USD-denominated, high yield, fixed-rate corporate bond market.
The Purchasing Managers' Index (PMI) is an index of the prevailing direction of economic trends in the manufacturing and service sectors.
The Consumer Price Index (CPI) is a measure of the average change over time in the prices paid by urban consumers for a market basket of consumer goods and services. Indexes are available for the U.S. and various geographic areas.
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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 December 15, 2021 presentation, "2022 Outlook: Playbook for a Shifting Economic Landscape" is reprinted by permission from City National Rochdale.
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