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May 21, 2021

The Beginning of a Multi-Year Expansion

City National Bank's investment leaders remain confident in their view that the U.S. economy has embarked on a lengthy expansion. They have increased their growth forecasts for this year, citing improving pandemic trends, consumer activity and personal wealth.

Despite a short-term rise in inflation, the team doesn't expect inflation to pose an obstacle to the growing economy.

“We continue to see strong evidence that we are at the early stages of a multi-year expansion," said Ben Goetsch, senior investment strategist for City National Rochdale, the bank's investment advisory organization.

Keep reading for your May market and economic update.

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Vaccines, Consumers Boost Recovery

Successful vaccine results, government stimulus measures and increased consumer spending are driving a strong recovery, according to the City National Rochdale team, who noted that 17 of the 20 financial and economic indicators it monitors show positive signs for an ongoing rebound in the second half of 2021.

The team now forecasts 5.5% to 7% gross domestic product growth in 2021 and 2.5% to 4.5% growth in 2022.

Broad economic data from multiple sources supports the view that U.S. GDP will experience "a very robust rate of growth" in 2021, City National Rochdale CEO Garrett D'Alessandro said. While GDP hasn't recovered to pre-pandemic levels, it should continue to expand and will likely reach an all-time high sometime in 2022, he said.

"We are now substantially wealthier as a country than we were before the pandemic started," D'Alessandro said, citing Bloomberg data that shows a sharp rise in household net worth and home prices since March 2020. That wealth is driving the recovery, with consumers having already pushed retail sales well past pre-pandemic levels.

"Retail sales are higher than they've actually ever been," D'Alesssandro said, and auto sales recently surpassed pre-pandemic levels as well.

Improving pandemic trends, combined with emergency government stimulus support, have facilitated strengthening in the economy.

The country is experiencing a strong downward trend in coronavirus cases, hospitalizations and fatalities, based largely on its robust vaccine rollout, Goetsch said, noting that U.S. economic growth is accelerating as pandemic-related restrictions like mask mandates ease.

While U.S. vaccine demand has declined, a majority of adults who want to be vaccinated have received at least one dose, while others are eager to receive the vaccine and many more may be willing, Goetsch said, citing data from the Centers for Disease Control and Prevention and the KFF COVID-19 Vaccine Monitor.

Much of the world, however, continues to struggle with the virus and their economies, Goetsch noted, citing Bloomberg data showing that coronavirus cases elsewhere in the world are starting to fall but remain far higher than in the U.S.

As Europe's recovery falters amid renewed lockdowns and a slower vaccine rollout, a reopening U.S. economy is unleashing consumer savings and pent-up demand, which will in turn lead to a "virtuous cycle" of job growth and higher incomes over several years, Goetsch said.

The City National team expects ongoing economic and demographic headwinds to inhibit growth in Europe through much of 2022.

U.S. Profits Surge

Meanwhile, U.S. corporate profits have exceeded expectations this year, signaling strong growth in 2021 and 2022. As large-cap, publicly traded companies wrap up their first-quarter financial reporting, the vast majority posted earnings growth that exceeded Wall Street estimates, Goetsch said.

Earnings growth should remain strong through next year, especially in the U.S., he added.

City National Rochdale managers also consider the various legislative spending and tax proposals in Congress as supportive of economic growth, despite potential tax increases that could result.

In the past two weeks, a weaker-than-expected U.S. jobs report and unexpectedly high April inflation figures caused some market concern, but City National Rochdale considers these to be short-term developments.

Because of strong economic growth, including demand for jobs, labor and commodities shortages are resulting in temporary supply-and-demand imbalances, Goetsch explained.

While the economy added fewer jobs than anticipated in April, according to a government report, near-term labor market issues should resolve in the coming months, D'Alessandro said, citing Bloomberg data showing pre-pandemic unemployment at 3.5% and a Blue Chip Economic Indicators consensus forecast for 4.7% joblessness by the end of 2021 and 4.1% by the end of 2022.

Several temporary factors are restraining the labor supply now, including enhanced unemployment insurance that exceeds average weekly earnings in the leisure and hospitality industry — an estimated $687 in benefits versus $477 in wages — and people stepping out of the labor force over childcare needs, safety concerns and other pandemic-related reasons, he said, citing U.S. Bureau of Labor Statistics and Center on Budget and Policy Priorities information.

Inflation Not Big Concern

Inflation may hit 3% to 3.5% in the next two quarters but should flatten by 2022 and then moderate to about 2% long-term, according to D'Alessandro. “Don't be alarmed and don't react to a transitory increase in inflation," he advised.

The City National Rochdale team expects the Federal Reserve to keep interest rates low at least through 2023.

Long-term structural forces — weaker organized labor, increased competition with overseas workers, technological advances that have lowered costs, and consumer expectations for modest price increases among them — have kept inflation in check for decades, D'Alessandro noted.

While some market observers have expressed concern about a return to 1970s-style stagflation (a combination of high inflation and stagnant demand), conditions today make a recurrence unlikely, he said. Rising wages matter only without a commensurate increase in productivity, D'Alessandro explained.

Labor costs grew only 2% net year-over-year in the first quarter of 2021 as productivity growth outpaced labor costs during the pandemic, he said, citing Federal Reserve Bank of St. Louis and Bloomberg data. In the 1970s, however, labor costs grew at three times the productivity rate.

Shifting From Traditional Portfolios

Trends in the global economic and earnings recovery help to drive City National's portfolio preferences — notably the team's continued affinity toward U.S. and emerging market Asia equities.

City National Rochdale Chief Investment Officer Tom Galvin, citing various stock indexes, noted that U.S. earnings have undergone shallower dips and stronger recoveries that those in other developed markets, while EM Asia earnings growth has been especially resilient.

Economic growth drives sales, which drive earnings and stock prices, Galvin noted, adding that U.S. and EM Asia stocks and fixed income investments remain strong. "Earnings are the ultimate driver of stock performance," he said.

U.S. operating margins should continue to expand in 2022, even with an anticipated increase in corporate taxes, according to Galvin, who noted that City National Rochdale estimates S&P 500 earnings per share will grow by 30% this year on average and 15% next year.

The City National investment team, citing a low-interest rate environment and fully valued stocks, continues to expect the traditional 60% equities-40% investment-grade bond portfolio to produce significantly more modest returns in coming years than it has in the past several decades.

They've been recommending that clients consider repositioning portfolios away from investment-grade bonds toward select equities and "opportunistic" debt, including high-yield municipal bonds.

The team has been increasing portfolio exposure to economically sensitive large-cap, small- and mid-cap equities. Small- and mid-cap stocks tend to outperform during recoveries and have more exposure to cyclical industries, which provides a bigger potential for upside earnings surprises, Galvin said, citing market data.

Small- and mid-cap industrial, financial, consumer discretionary, healthcare, real estate and materials stocks should benefit from positive economic growth, he said, citing data from various sources.

Plan For Tax Changes

Nichole Walker, City National Bank senior wealth planner, outlined several potential changes to tax policy under the Biden administration and the Democratic-controlled Congress, including possible shifts in income, capital gains, and gift and estate taxes that could hit wealthy families and individuals. She cited a strong likelihood that the capital gains and top income tax rates will increase.

Walker recommended that investors consult with their financial planners to consider taking advantage of certain favorable tax policies now — before potential changes that limit or eliminate them.

Investors, for example, might accelerate the establishment and funding of certain trusts that can help save families millions in estate taxes, consider taking advantage of the current lifetime gift tax exemption this year, and gift interests in intra-family businesses to capture current valuation discounts.

Clients might also recognize long-term capital gains this year to take advantage of current rates, and accelerate ordinary income by taking bonus payments and exercising non-qualified stock options this year.

In these turbulent times, City National encourages you to review your investment portfolio with your advisor. Get in touch with a City National advisor 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 by signing up for City National Bank's newsletters here. Delivered biweekly, straight to your inbox.

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 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 May 19, 2021 presentation, "Beginning of a Multi-Year Expansion" 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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