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October 22, 2021

Are the Labor Shortage, Inflation and Supply Chain Disruptions a Concern?

According to City National Bank investment leaders, high consumer and business spending should fuel a self-sustaining U.S. economic expansion well into the future. They see inflationary pressures and supply chain disruptions as temporary issues that will resolve themselves in 2022.

While now expected to last into the second half of next year, elevated inflation is largely transitory, they believe. According to the team, current inflation is being driven by pandemic-related supply and demand imbalances for goods, services and labor.

"We still believe we are in the early phases of a multi-year economic expansion," said Ben Goetsch, senior investment strategist for City National Rochdale, the bank's investment advisory organization, during the team's monthly market update on Oct. 20. The group foresees a durable expansion extending beyond 2022.

Chart of Economic and Financial Indicators
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Potential for Significant Consumer Spending Exists, Fuels Favor for Stocks Over Bonds

American households, supported by government emergency stimulus checks, have amassed nearly $2.5 trillion in savings during the pandemic while businesses have seen increased profits, he noted. "That is a lot of fuel for future consumer spending," Goetsch said.

Given high valuations across asset classes, healthy corporate earnings and enduring low interest rates, the Rochdale team continues to favor stocks over bonds, with an emphasis on U.S. equities and emerging-market Asia stocks as well as high-yield debt.

"The U.S. continues to be better positioned in this recovery than other markets," Goetsch said.

Chart of historical vs near-term forecast returns

Rochdale Strategists Hold Optimistic Economical Outlook

"Our outlook on the economy is that of excitement and optimism," said Paul Single, managing director, senior economist and senior portfolio manager at City National Rochdale.

The strength of household and corporate balance sheets should allow the U.S. economy to "plow through" inflation and supply chain bumps, Single said.

"Households went out and spent, and they spent a lot of money," he added, citing U.S. Bureau of Economic Analysis data showing surging consumption and gross domestic product in the first half of this year. "These are really, really robust numbers."

chart of GDP actual and forecast

Projected GDP Growth in 2022

The Rochdale team expects economic growth to remain strong through 2022 while moderating and normalizing from the boom seen during the pandemic recovery in the first half of 2021.

In the first and second quarters of 2021, GDP was up 6.3% and 6.6% respectively. The team reported that it slowed to an estimated 4.5% to 5.5% in the third quarter and 3% to 5.5% in the current quarter. They forecast 3.5% to 4.5% GDP growth in 2022.

Graph of City National Rochdale forecasts

Corporate Earnings Projections for 2022

Similarly, S&P 500 corporate earnings should remain strong next year, growing by roughly 11%, while moderating from the consumer-driven jump seen in the first half of this year, according to Rochdale leaders, who bumped up their earnings outlook for 2022.

CNR S&P 500 EPS Estimates

Supply Chain Recovery and Increased Wages Fend Off Inflation Concerns

Imbalances in supply and demand for goods, services and labor have pushed inflation higher than previously forecast but these areas should come back into equilibrium by the second half of 2022, according to Goetsch.

The Rochdale team sees wage growth mostly contained to a few areas where employees were hit hard by pandemic shutdowns — leisure and hospitality and retail — and therefore unlikely to spark a longer-term wage spiral that would drive inflation.

Goetsch noted that many workers — facing childcare challenges and fears of catching the coronavirus — aren't looking for jobs now. In September, 1.6 million people reported they weren't looking for work because of COVID-19, he said, citing Bureau of Labor Statistics data.

“It is hard to hire workers fast enough to meet that demand," said Goetsch, who expects the labor supply to grow in the coming months.

Graph showing COVID has continued to impact labor supply

Will Stagflation Occur in 2022?

Rochdale investment leaders dismissed concerns over "stagflation," a combination of high inflation and high unemployment. The so-called misery index, the sum of the year-over-year change in the Consumer Price Index (CPI) and the unemployment rate, is far lower than in the 1970s and 1980s and should continue to fall, along with inflation and unemployment, according to Single, who cited Bureau of Labor Statistics figures.

Graph showing the Misery Index

Is the Labor Shortage a Long-Term Economic Concern?

"The excitement is really in labor," Single said. "Businesses are opening up faster than people are moving back into the workforce. There are more job openings than there are people looking for jobs," with about 1.2 openings per job seeker, he said, again citing BLS statistics. "Eventually we will get that corrected."

Graph showing Job Openings per Job Seeker

The Current 10-Year Inflation Outlook

While the "transitory" inflation is lasting longer than anticipated, Single, citing Bloomberg and University of Michigan data, said the financial markets and consumers don't expect the condition to last. The University of Michigan forecasts a 2.5% to 3% inflation rate over five to 10 years, a rate that won't worry Federal Reserve officials, he said.

Graph of Inflation Expectations

High household net worth, which far outpaces that of previous recoveries, should help support economic growth, according to BLS data. “The fact that people have this much money will give them confidence in maintaining this level of spending for some time," Single said.

Graph showing Household Net Worth

Fed Anticipated to Start Tapering Asset Purchases by Summer

Meanwhile, Rochdale leaders, based on comments from U.S. Federal Reserve Chair Jerome Powell, expect the Fed in November to start tapering the asset purchases they've been making to provide stimulus during the pandemic and to end the tapering next summer. They also anticipate the Fed will hold steady on interest rates for at least a year.

"The Fed is still going to be accommodative" and continue its extraordinary support to sustain the economy, said Charles Luke, fixed income co-director at City National Rochdale, who sees concerns over Fed tightening as overstated.

Tom Galvin, City National Rochdale's Chief Investment Officer, noted that the last tapering didn't stop an equities rally, with the S&P 500 18% higher a year later. “Then, as today, we view the Fed's decision to taper as a vote of confidence in the economic outlook," he said.

Graph of stock market performance during taper

More broadly, returns for equities and bonds should be more moderate than in the past decade, given high valuations, so Rochdale leaders have positioned client portfolios accordingly.

The current stock market rebound marks one of the largest without a 10% correction, so the team expects some pullback, Galvin said, citing Bloomberg and FactSet data showing the S&P 500 is up more than 100% from the March 2000 pandemic trough.

Galvin said that pullbacks and volatility will present a buying opportunity rather than represent an end to the multi-year expansion.

Number of Trading Days for Bull Market to Double

Low Interest Rates Inform High-Yield Credit Preferences

Low interest rates continue to inform Rochdale's preference for high-yield debt, and Luke noted that during the last Fed tapering in 2013, high-yield bonds significantly outperformed investment-grade bonds.

"We very much recommend that you consider high-yield credit," Luke said. Investment-grade bonds won't be wiped out but aren't likely to provide the same long-term returns they did over the past two decades, he said.

Graph of Selected Asset Class during taper

Rochdale Continues to Watch EM Asia

While maintaining a preference for Emerging Markets (EM) Asia over other emerging market regions, the team is keeping an eye on activity in China, where stocks have experienced a significant pullback. "We are on watch as it relates to our overweight in EM Asia," Galvin said.

Overall, equity returns will outperform fixed income, and Rochdale believes its positioning will produce strong performance and a hedge against inflation, according to Galvin, who noted that the team has added small-cap U.S. stocks to its overweight holdings.

"We are confident in our forecast," Galvin said.

City National encourages you to contact you advisor to review your investment portfolio. Our wealth planning advisors are ready to answer your questions and help you make adjustments to your portfolio in response to current events and market trends.

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.

The material contains forward-looking statements regarding intent, beliefs, or current expectations which are used for informational purposes only. Readers are cautioned that such forward-looking statements are not a guarantee of future performance, involve risks and uncertainties, and actual results may differ materially from those statements as a result of various factors. The views expressed are also subject to change based on market and other conditions. Furthermore, the opinions and information presented do not involve the rendering of personalized investment, financial, legal, or tax advice.

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.

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

Adjustments to portfolio strategies are based on guidelines set forth by City National Rochdale’s Asset Allocation Committee. Individual client allocations among strategies, asset classes, portfolio weightings may be higher or lower given differences in portfolio holdings, client imposed restrictions, and/or the customized strategy implemented by each client’s portfolio manager.  These differences may have a material impact on individual client’s performance returns.

Any opinions, projections, forecasts, and forward-looking statements presented herein are valid as on the date of this document and are subject to change.

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.

Indices are unmanaged and one cannot invest directly in an index. Index returns do not reflect a deduction for fees or expenses.

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.

This material represents an assessment of the market environment at a specific point in time and is not intended to be a forecast of future events or a guarantee of future results. 

This presentation is for general information and education only. City National makes no representations or warranties in respect of this presentation and is not responsible for the accuracy, completeness or content of information contained in this presentation. City National is not responsible for, and expressly disclaims all liability for, damages of any kind arising out of use, reference to, or reliance on any information contained in or from the site. The information in this presentation should not be used to obtain credit or for any other commercial purpose nor should it be construed as tax, accounting, regulatory or legal advice. Rules in the areas of law, tax and accounting are subject to change and open to varying interpretations and you should seek professional advice from your advisor. Nothing in this presentation should be construed as an offer, or solicitation of an offer, to buy or sell any financial instrument. It should not be relied upon as specific investment advice directed to the viewer's specific investment objectives. Any financial instrument discussed in this presentation may not be suitable for the viewer. Each viewer must make his or her own investment decision, using an independent advisor if prudent, based on his or her own investment objective and financial situation. Prices and availability of financial instruments are subject to change without notice. Financial instruments denominated in a foreign currency are subject to exchange rate risk in addition to the risk of the investment. City National Bank (and its clients or associated persons) may, at times, engage in transactions in a manner inconsistent with this presentation and, with respect to particular securities and financial instruments discussed, may buy from or sell to clients or others on a principal basis. Past performance is not necessarily an indication of future results. 

Alternative investments are speculative, entail substantial risks, offer limited or no liquidity and are not suitable for all investors.  These investments have limited transparency to the funds’ investments and may involve leverage which magnifies both losses and gains, including the risk of loss of the entire investment.  Alternative investments have varying, and lengthy lockup provisions. 

The expected returns shown do not include fees for trading costs (e.g., commissions) or any fees charged by your financial advisor. Please speak to your financial advisor for a complete understanding of all fees.

City National Bank provides investment management services through its wholly owned subsidiary City National Rochdale, LLC, a registered investment advisor. Content from the October 20, 2021 presentation, "Transition to a Self-Sustaining Recovery" is reprinted by permission from City National Rochdale.

City National (and its clients or associated persons) may, at times, engage in transactions in a manner inconsistent with this article and, with respect to particular securities and financial instruments discussed, may buy from or sell to clients or others on a principal basis. Past performance is not necessarily an indication of future results. This article may not be reproduced, distributed or further published by any person without the written consent of City National. Please cite source when quoting.

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