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November 19, 2021

What's Causing Inflation, Supply Chain Issues and the Worker Shortage?

City National Bank investment leaders remain confident in the U.S. economy. They expect high inflation to ease by the second half of 2022 as supply chain bottlenecks resolve themselves.

“The economic backdrop still remains very positive. Consumers continue to spend money, they are driving the recovery," said Ben Goetsch, senior investment strategist at the bank's investment advisory organization, City National Rochdale, during a recent market update.

Now at a 30-year high, inflation is likely to peak this quarter and remain high into the mew year, then start to taper off after the first quarter, said Paul Single, City National Rochdale managing director, senior economist and senior portfolio manager.

Given high equity valuations, low interest rates and an outlook for strong American corporate earnings, the investment team maintains its preference for portfolios weighted toward U.S. and emerging market-Asia stocks and opportunistic fixed income, notably high-yield bonds.

The team expects positive, albeit moderate, returns in its portfolios.

Chart - Historical vs. Near-Term Forecast Returns
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What's Causing Supply Chain Disruptions?

Goetsch said that supply chain disruptions, a key inflation driver now, should resolve by the second half of next year. He explained that several dynamics tied to the pandemic, including volatility and dramatic shifts in consumer demand, have created these disruptions.

As consumers stayed home and canceled trips in response to the coronavirus outbreak, their spending shifted heavily away from services toward goods, including durable home improvement products, Goetsch noted, citing City National research and Bloomberg data.

At the same time, they enjoyed a healthy ability to spend as government emergency stimulus checks arrived in their bank accounts, Goetsch noted. The shifts in consumer spending patterns during the short, severe pandemic recession and subsequent recovery have placed significant pressure on manufacturers, who are more accustomed to gradual changes, he explained.

“There was a very sudden, jarring drop followed by a very sudden increase in demand," Goetsch said.

Chart - Consumer Demand, Manufacturing Production, Transportation
Chart - Personal Consumption Expenditures, Goods vs. Services

Transportation issues also have fueled supply chain disturbances, he noted. Pandemic policies at ports around the world, including strict measures for ships moving in and out of China, have created delays and greatly diminished the supply of ships on the go. Goetsch noted, however, that some of these pressures have started to abate.

"Ports are starting to work through their backlog," he said.

These disruptions have hit suppliers, leading to low inventories and higher prices as consumer demand for goods surged, Goetsch said, citing data from Opportunity Insights, Affinity Solutions, OpenTable, the TSA and Apple. The situation is starting to improve, he added, referring to Bloomberg data.

Chart - ISM Manufacturing Index

In addition, a domestic trucking shortage has hit "last mile" transportation, as many drivers left the workforce entirely or shifted to other industries, causing a "massive imbalance" that should start to ease next year, Goetsch said, citing Bloomberg and FTR data.

Meanwhile, Asian manufacturing has been slow to rebound from pandemic-related disruption but is now improving, according to Goetsch, who cited Bloomberg and World Bank data.

Chart - Truck Driver Labor Pool vs. Active Truck Utilization
Chart - Market PMI

Inflation, GDP Trends Expected to Normalize

Economists expect gross domestic product and inflation to return to typical trends, Single noted, citing Bureau of Economic Analysis and Bloomberg data.

Bloomberg forecasts 5% GDP growth in the current fourth quarter, “an extremely strong number" driven by consumer spending, continued improvement in inventories, pandemic developments and the holiday season, Single said.

He predicted that GDP growth should return to a pre-pandemic 2.5% rate by late next year, voicing hope that supply chain shortages will be fixed by then.

Charts - GDP, Inflation

Transportation prices are fueling the Consumer Price Index, a key inflation measure, along with rising food and beverage prices, while apparel is exerting downward pressure on growth, Single said, citing Bureau of Labor Statistics data. Most consumer categories, however, are well within their normal inflation ranges.

Charts - CPI Composite, CPI Components

Single, citing comments from Federal Reserve Chair Jerome Powell, noted that the Fed doesn't appear greatly concerned about inflation long term. They have pointed to a lack of broad-based pricing pressures, and stable wage increases in most sectors. In addition, the Fed sees long-lasting forces, including demographics and free-trade policies, continuing to keep inflation low globally.

He also cited the Fed's references to moderating price gains in high-inflation items like used cars.

Chart - Powell's dashboard for inflation

While wage inflation is up to some extent, the big gains are concentrated at the lower end of the spectrum — hospitality, retail and transportation — where businesses are trying to hire workers, Single said.

Higher wages for lower-income workers, and high savings and investments in other groups, are helping to keep consumer demand and the economy going, Single said. The long term 2.5% inflation rate won't support extended wage gains, he added.

City National Rochdale's interest rate forecast remains stable and low, with no Federal Reserve rate hikes expected until late 2022, according to Charles Luke, Rochdale co-director for fixed income. These low rates will support both the equities and high-yield debt markets, Luke said.

He said that market expectations for rate hikes are volatile and inconsistent with Fed projections, citing Rochdale and Bloomberg data.

Table - CNR Interest Rate Forecasts

Job gains, meanwhile, are outperforming those seen in the post-financial crisis recovery more than a decade ago, with openings outpacing the number of unemployed workers, Single said, citing BLS data.

"The demand to hire people is extraordinarily strong," he said. “There are more jobs available than there are people looking for jobs," a condition that should recede over time. Also, the number of people quitting jobs is at an all-time high, Single said.

Workers who are not seeking employment now appear less worried about COVID-19 than they did earlier in the crisis, but older people and women are participating in the workforce at lower rates than others, indicating that health concerns and child-care challenges are affecting their willingness to rejoin the labor force, Single said, citing statistics from the BLS, Haver and Jefferies Economics.

Chart - Job Openings and Unemployed Workers
Charts - Voluntary Job Separation, Not Seeking a Job Because of Pandemic
Charts - Labor Force Participation

According to Luke, nearly $580 billion in newly approved federal infrastructure spending will boost construction and manufacturing and replace jobs over the next 10 years without adding new taxes, which supports investment. While the spending figure is lower than initially proposed, he said, “We think the infrastructure bill is good for growth, and it's good for our overall portfolios."

Chart - Infrastructure Spending

City National Rochdale continues to encourage investors to consider high-yield bonds in the current environment, Luke said. While the investment leaders are keeping an eye on stress in China's high-yield property sector, global high-yield markets appear insulated from these problems, he said.

The U.S. high-yield market has generated strong returns since hitting a low in March 2020, and EM debt remains stable despite issues in China's property sector, Luke said, citing multiple market sources.

City National Rochdale remains optimistic toward China long term but has the country on watch for the short term, Chief Investment Officer Tom Galvin said.

Chart - U.S. High Yield and Emerging Markets Debt Performance

In the U.S., Galvin noted, earnings for S&P 500 companies continued to perform better than expected in the third quarter, with solid results across all sectors. He said that results have exceeded market forecasts in every quarter since the second quarter of 2020, citing statistics from Rochdale and FactSet.

Better-than-expected earnings provide support for rising equities valuation, he said. According to Galvin, the investment team is biased toward the upper end of its 2022 earnings forecasts and expects to update its outlook soon.

Charts- Q3 S&P 500, Q3 S&P 500 Sector EPS Growth
Charts - Consensus Bottom-Up 2022 EPS Forecasts

Speculative retail investing has surged during the pandemic and driven the stock market rally, with bullish call options reflecting increased optimism, Galvin said. He remarked that such speculative behavior is historically linked to market shocks, citing Bloomberg data that shows increased margin and option volumes leading to bigger rallies and sharper pullbacks.

Should there be another market shock, he said, "We think our positioning should serve us well." The organization believes its high-quality stocks will strongly outperform the S&P 500 in the long term and during market pullbacks, Galvin said.

Stocks historically are the best hedge against inflation and won't be derailed by modest inflation, he said, citing FactSet and St. Louis Fed data. Falling inflation is better for stock returns, Galvin added.

Charts - Core Equities, Equity Income

If you have questions about your investment portfolio, City National encourages you to contact your advisor. Our wealth planners can answer your questions to 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 November 17, 2021 presentation, "Looking Through Temporary Disruptions" 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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