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January 28, 2022

GDP Growth, Interest Rates and Investing in 2022

Recent stock market volatility represents a healthy correction and an appealing buying opportunity, according to City National Bank investment leaders, who reiterated their forecasts for solid equity returns and a multiyear U.S. economic expansion.

City National Rochdale, the bank's investment advisory organization, continues to project more moderate average stock returns in the coming years compared to historical performance, given relatively high valuations.

“We think there's a positive reason to stay confident that equity investors will generate and enjoy a positive return for 2022," Garrett D'Alessandro, City National Rochdale CEO, said during the team's Jan. 26 market update. This month's stock market swings have removed excess optimism and "excessive speculative behavior by investors," he said.

The Rochdale team cited several factors contributing to recent market gyrations, including the U.S. Federal Reserve's indications it will raise benchmark interest rates this year, higher inflation and wages, economic disruptions from COVID-19, heightened geopolitical tensions, profit taking and aggressive selling by hedge funds, short-term traders and algorithmic trading.

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Will GDP Grow in 2022?

Despite the volatility, the investment managers maintain their preferences for high-quality and income-generating U.S. stocks, emerging-market Asia equities, high-yield bonds, floating-rate credit and other alternatives to investment-grade debt. They said that stocks remain relatively attractive compared with bonds, citing FactSet data.

Chart - S&P 500 Earning Yield & 10 Year Treasury Yield

That positioning reflects, in part, Rochdale leaders' expectations for above-average U.S. gross domestic product growth this year, driven by high consumer demand, strong household and company balance sheets, and businesses' need to build up inventories and spend on greater plant capacity. However, they see economic growth moderating in 2022 compared to last year's powerful post-lockdown rebound.

City National Rochdale forecasts GDP will grow by 3.5% to 4.5% this year, compared with an estimated 5.25% to 6% in 2021. The outlook includes projected 7% to 17%, above-average growth in corporate profits in 2022, and 3.7% to 7.5% inflation, which the organization expects will moderate to the 4% neighborhood by year-end.

Chart - GDP Growth

Is Omicron Harming the Economy?

D'Alessandro forecasts inflation will soften in the second half of the year as temporary pandemic-related disruptions, notably supply chain backlogs and shifting consumer preferences, recede.

The COVID-19 omicron variant shows sign of peaking “and while it has put a slowdown into Q1 activity, we think that economic disruptions won't last more than another couple of months and will be less severe than in earlier COVID waves," D'Alessandro said, citing government health agency data.

Chart - Inflation

D'Alessandro noted that dining out and travel continue to be hampered by the pandemic, citing OpenTable and TSA data. Travel and restaurant disruptions may plateau and turn around in the next month or two, he said.

Overall, the U.S. economy has recovered quickly, with most measures meeting or exceeding pre-pandemic levels.

Chart - Activity Levels During Pandemic
Chart - U.S. Economy Recovery

Paul Single, City National Rochdale's senior economist, senior portfolio manager and managing director, noted that 17 of the organization's 20 economic and financial indicators appear positive for the next six to nine months, supporting the multiyear economic expansion position.

“It doesn't get much better than what we have, due to household and corporate balance sheets being so strong," Single said.

Equity market valuations and the political environment are in neutral territory, while the geopolitical risk looks negative given Ukraine's rising tensions.

Fed to Raise Interest Rates Multiple Times in 2022

The Rochdale team, like the broader market, expects the Fed to raise interest rates at least four times this year — once per quarter — which is a bit more aggressive than what officials signaled in December, Single noted.

The Fed needs to act to get the benchmark interest rate above 1% and reduce its bond portfolio, which the central bank built up during the pandemic to buoy household cash flow, he said. Single predicted the Fed would reduce its balance sheet to about $6.4 trillion from the current $9 trillion in the next two or three years.

Fed officials are particularly concerned about rising housing costs, which are contributing significantly to the current spike in inflation, Single noted, citing Bureau of Labor Statistics.

Chart - CPI

Stocks tend to perform well during periods when the Fed raises interest rates and when the Fed removes stimulus because the economy is strong, according to Rochdale managers, who welcomed the recent market volatility.

"This downturn is much needed, it's long overdue," said Tom Galvin, City National Rochdale's chief investment officer, citing the historic equities run that preceded it. “It's a good thing. This is a healthy correction although it sure doesn't feel healthy when it occurs."

Short-term volatility is normal and indicates investors should stay the course, according to Galvin, who noted that the S&P 500 is trading below fair value, leaving room for attractive upside in total returns for the first time in a long time.

While citing FactSet and Bloomberg data, Galvin noted that a selloff in speculative, unprofitable, emerging tech stocks drove much of the recent volatility. City National Rochdale concentrates on established, high-quality, reasonably valued companies, he said.

Chart - Market Volatility
Chart - Cumulative Return & CNR Core Equity Strategy vs Speculative Tech

"The stock market always gets a case of the jitters when the Fed starts hiking rates," Galvin said, citing Bloomberg data showing that equities have performed well in rising rate environments. “We're optimistic that rising rates are not going to significantly derail equity returns."

Chart - Interest Rates Historical Data

Investing During Inflation

The environment remains challenging for investment-grade bonds, which can't keep up with inflation and will remain low as interest rates rise, according to Rochdale leaders, who favor high-yield bonds and other opportunistic and alternative debt.

Opportunistic income investments are resilient to rate increases and offer protection from inflation, according to Charles Luke, co-director, fixed income, at City National Rochdale. The credit environment overall is healthy now, marked by a low default rate and low cost of money, he said.

The best high-yield performers so far this year are the lowest quality companies, which indicates no significant stress in the market, Luke said, citing FactSet data.

"We view this as a nice point to add exposure," he said.

Chart - Year-to-Date U.S. High Yield Risk Measures

Floating rate credit has started the year in a strong position, with two of the largest weekly fund inflows ever and a record of outperformance during Fed rate increases, Luke said.

With core fixed-income yields around 1%, alternative investments such as higher-returning structured credit, capital leasing, direct lending and reinsurance play an important role in portfolio allocation, Luke said, citing various market data sources.

Chart - Alternative Investments

City National encourages you to review your investment portfolio with your advisor. Contact our financial professionals today to ask questions and receive help with your wealth planning needs. You also are encouraged to keep up-to-date with the latest economic perspectives and shifting global markets during the pandemic by signing up for City National Bank's newsletters here.

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.

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 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.

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.

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 January 26, 2022 presentation, "Market Update" 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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