January Update

City National Rochdale

January 20, 2024

Happy New Year! Below is an update with our latest thinking on the economy, markets, and portfolio considerations. Please feel free to share this with your clients as appropriate.

As we kick off 2024, we see a mixed outlook for the economy and financial markets. On the positive side, the outlook for the U.S. economy is modestly improving – we have lowered our probability of a mild recession in the first half of the year to 50%. On the negative side, however, uncertainty remains regarding Fed policy, corporate earnings, U.S. elections, and geopolitical factors.

After slowing down most of Q4 2023, the U.S. economy picked up activity at the end of the year. While job openings in the labor market continue to moderate, we continue to see strength in the form of average hourly earnings growth and lower than expected unemployment claims. The state of the labor market will be a key factor in determining how the U.S. economy performs throughout 2024.

U.S. financial markets ended the year exceptionally strong, rallying into year-end based in part on expectations for the Fed to aggressively cut interest rates in 2024. While market expectations are for six rate cuts with the first one happening in March, we expect the first move to happen later in the year with only 2-3 cuts total.

CURRENT EVENTS

The U.S. Presidential primaries are heating up, and we expect this to capture headlines throughout the year. Congressional leaders reached an agreement for a $1.6T federal budget for 2024, but now the House and Senate have the challenging task of passing the underlying bills to fund the government for the year – the back and forth of these negotiations will continue to create uncertainty for investors.

Geopolitical tensions remain high with recent focus on the escalating risks in the Middle East. The recent strikes on Houthi rebel forces in Yemen has thus far had a modest impact on oil prices, but uncertainty remains around how this situation might evolve over the coming months. While the recent thawing in U.S.- China relations is welcome, that sentiment could shift at any time, especially with the outcome of the presidential election in Taiwan. We continue to believe that the U.S. economy is the best place to be allocated at this time.

ECONOMIC OUTLOOK

The December Consumer Price Index (CPI) numbers came in slightly higher than expected, with inflation accelerating slightly from the prior month. Headline CPI stands at 3.4% year-over-year with Core CPI at 3.9%. While the downward trend in inflation seen throughout 2023 likely remains intact, further progress from here will likely be slow. Supply chain improvements have brought the yearly change in goods prices back near 0%, but services inflation remains elevated due to above average wage growth and shelter/housing costs.

The upshot here is that consumer spending, the largest engine for growth in the US economy, remains resilient, supporting our recent reduction in the probability of a recession in the first half of the year. However, as long as service prices remain elevated, Fed policymakers will likely remain fearful of a reacceleration of inflation and hold off on any interest rate cuts in the near-term.

FINANCIAL MARKETS

After two months of strong gains and a year-end close to record highs, equity markets have seen renewed selling pressure and volatility to start the year. Caution about the timing of rate cuts, potentially overbought conditions, and geopolitical concerns have all weighed on sentiment.

International equities are lower as well to start the year. European stocks were hampered by a reacceleration in December inflation, while Chinese stocks led Emerging Markets lower amid continued concerns about its economy, including more evidence of China’s persistent property slump.

For many bond sectors, fixed income yields are about exactly where they were to start 2023. While most fixed income generated positive returns last year, total return over the past two years (2022-2023) for investment grade bonds are still negative due to the significant headwinds in 2022 from the Fed starting to increase interest rates.

As such, many bonds are still trading at discounts to their par values while still paying coupon income at the highest levels in over a decade. While defaults are expected to increase modestly as the economy slows in the first half of the year, we are not expecting a major credit cycle ahead. Given this backdrop, whether interest rates fall in 2024 or not, the current setup for fixed income is still attractive for investors.