City National Bank's investment leaders remain confident in forecasting a long-term U.S. economic expansion despite current inflationary pressures and concerns over the surging coronavirus delta variant.
Healthy consumer savings and pent-up demand, lifted by government stimulus measures, should drive multiyear growth, with the economy now experiencing the early stages of that growth, the bank's investment team said during a market update Wednesday.
“We're confident in the multiyear expansion thesis despite these short-term concerns," said Tom Galvin, chief investment officer for City National Rochdale, the bank's investment advisory organization.
U.S. gross domestic product has recovered unusually quickly, already surpassing pre-pandemic levels as the labor market recovers and wages increase, the investment managers noted, citing Bloomberg data.
“It's important to step back and look at the big picture and what we see in the ultimate trajectory of the market," Senior Investment Strategist Ben Goetsch said.
The investment managers anticipate positive but relatively modest portfolio returns near-term.
They continue to recommend U.S. and emerging market Asia stocks, despite high S&P 500 valuations and concerns about new domestic policies in China that could affect profits, and retain a favorable stance toward opportunistic debt, including U.S. high yield municipal bonds, given the low-interest-rate environment.
Galvin cited an "extraordinary rebound" in corporate profits, citing FactSet data showing a more robust earnings surge than in earlier recoveries.
While coronavirus cases are rising as the highly contagious delta variant spreads, Rochdale leaders don't consider the resurgence a significant long-term economic issue given that vaccines are holding up extremely well, especially in preventing severe outcomes such as hospitalizations and fatalities, Goetsch said.
"As vaccination rates rise we expect the worst outcomes to be avoided," he said, citing Centers for Disease Control and Prevention and Department of Health and Human Services data showing surges focused in states with lower inoculation rates and that unvaccinated patients account for 98% of coronavirus hospitalizations since mid-July.
COVAX, the cooperative effort to distribute coronavirus vaccines around the world, expects to have enough doses to cover half the global population by year-end — up from 30% now — which should help in the fight against further virus mutations, Goetsch said.
So far, the current rise in coronavirus cases has caused a slight drop in time spent away from home but less so than in previous surges, Goetsch said, citing Opportunity Insights and Google data. Rochdale leaders are monitoring consumer mobility closely, however, since the economy could be affected if the delta variant causes people to stay home and spend less, he added.
Most children will return to in-person classes this fall, a major shift from widespread remote and hybrid learning a year earlier, Goetsch said, citing data from Burbio. Rochdale is keeping an eye on those trends as well, as changes could affect employment.
Consumers, who account for two-thirds of the U.S. economy, have amassed a historically high $2.5 trillion in savings, which should help fuel multiyear economic growth and a "virtuous cycle" involving more hiring, greater income, more spending, greater production, higher market wealth and greater investment, the City National Rochdale team said.
"The recovery story has everything to do with the strong consumer," said Rachael Crane, portfolio manager. As the economy reopens following pandemic shutdowns, there appears to be significant pent-up demand left, she said, citing Bloomberg data. Consumers continue to save more than normal despite higher spending this year, which should drive growth beyond 2021, she said.
This powerful consumer demand is spurring rapid hiring, although the delta variant poses a risk to the labor supply, according to Crane, who cited Bloomberg data showing a significant increase in employment since April 2021.
"We really are seeing a lot of acceleration in hiring and in fact there's such a strong demand in labor that the job openings have exceeded the unemployed," she said.
Unique pandemic issues, including labor supply and demand imbalances, have boosted average hourly earnings by 4% year over year, Crane noted, again citing Bloomberg. “What we've seen so far is that companies have been able to pass on these costs and it has not hit earnings."
The Rochdale team believes rising inflation is a short-term condition tied to imbalances both in the labor market and the supply chain. Declining inventories show the limits of the economy's ability to meet quickly rising demand as the supply chain reopens, according to Crane.
Inflationary pressures will likely remain high into 2022, then moderate when supply and demand return to equilibrium, she said. Longer term, inflation should be contained by globalization and demographic trends, she explained. Crane cited Bloomberg data showing that outliers are driving near-term inflation, which appears to be more modest when they're removed.
City National Rochdale forecasts 5.5% to 7% GDP growth in 2021 and 3.5% to 4.5% in 2022, and expects Federal Reserve interest rates to remain low both years. With corporate profits likely up an unexpectedly strong 35% to 45% this year, the team now forecasts 6% to 16% earnings growth in 2022, Galvin said, citing FactSet data.
While Rochdale leaders expect the rally in U.S. equities to endure, they also anticipate more modest returns and greater volatility, saying they would view a market correction as an investing opportunity.
Galvin, noting the S&P 500's historic run, expects a correction in the 5% to 10% range, although the timing is unclear. "We would likely be more aggressive in our equities exposure because the upside at that point would likely be positive," he said.
While stocks seem fully valued, that doesn't necessarily mean they'll lose ground, Galvin said, citing the strong economy and earnings.
The team expects the U.S. corporate tax rate to increase to 23% next year from the current 21%, which would shave 4% from the earnings growth forecast. Nonetheless, they expect U.S. earnings to remain vigorous, likely up about 11% next year after a 41% post-pandemic rebound this year.
Based on normalizing consumer activity, rebuilding inventories and improving supply chains, Rochdale managers are focusing investments on financial, consumer discretionary and IT stocks, as well as healthcare and industrial equities. The team anticipates those sectors will significantly outpace the S&P 500 overall next year.
Rochdale leaders expect U.S. capital gains taxes to rise as well next year, although it's unclear by how much. Galvin recommended investors anticipating large capital gains to talk to their financial advisors and put a plan in place to address the likely increase.
The team noted that state tax revenues have now surpassed pre-pandemic levels, creating the potential for more infrastructure spending, and said new federal infrastructure spending should help extend the economic expansion.
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