Market and economic update - U.S. Bank

Market analysis

October 18, 2021

At a glance

Inflation measures accelerated in the past month, though consumers shrugged off much of their concern. Corporate earnings so far are solid and in line with market expectations.

This informational material is provided by U.S. Bank Asset Management Group who provides analysis and research to U.S. Bank and its affiliate U.S. Bancorp Investments. Contact your wealth professional for more details.

33.9%

The performance of the Financials sector so far this year. It is the

second-best performing sector in the S&P 500 this year.

TERM OF THE WEEK

Loan loss reserves ? An expense set aside as an allowance for uncollected loans and loan payments. This provision is used to cover different kinds of loan losses such as nonperforming loans, customer bankruptcy and renegotiated loans that incur lower-thanpreviously-estimated payments.

"Going forward, inflation likely will remain elevated relative to historical averages while the mix under the surface changes: Some supply chain constraints will ease, but the labor market remains tight."

- Robert Haworth, CFA, Senior Investment Strategist, U.S. Bank



Investment products and services are: NOT A DEPOSIT ? NOT FDIC INSURED ? MAY LOSE VALUE ? NOT BANK GUARANTEED ? NOT INSURED BY ANY FEDERAL GOVERNMENT AGENCY

[ 1 ] Important disclosures provided on page 4.

Global economy

Quick take: Inflation accelerated further and may be damaging consumer confidence, though consumer spending remains strong. Meanwhile, supply chain constraints highlight the slowing in economic growth.

Our view: Economic growth is positive and vaccination progress continues in much of the world. U.S. coronavirus cases and hospitalizations are declining. Overall, the global economy is in expansion despite risks from the coronavirus, fiscal and monetary policy uncertainties.

The Consumer Price Index and Producer Price Index accelerated, though core inflation (which excludes volatile food and energy prices) steadied. The forward path of inflation remains uncertain between temporary supply constraints and potentially stickier inflation coming from higher wages and housing costs. The small business confidence survey shows alltime highs in employee compensation plans, labor costs and continued difficulty in finding qualified workers for open positions. Going forward, inflation likely will remain elevated relative to historical averages while the mix under the surface changes: Some supply chain constraints will ease, but the labor market remains tight.

The preliminary October consumer confidence survey from the University of Michigan indicates inflation pressures weigh on consumer attitudes. This may pull forward some spending to avoid future price increases. September retail sales rose compared to upwardly revised August sales. Spending shifted toward goods relative to services, such as travel. The interaction of confidence, spending and hiring will be key factors for inflation impacts on economic growth in the months ahead.

China economic deceleration remains ongoing, with both imports and credit growth slowing in September and third quarter growth slowing to 4.9 percent year-over-year, down from 7.9 percent in the second quarter. The slowdown reflects some coronavirus shutdowns and recent power shortages. Growth is still likely to meet central planners' 6 percent 2021 target as officials navigate the pandemic and remain nimble with monetary and fiscal policies amid current shipping bottlenecks.

[ 2 ] Important disclosures provided on page 4.

Equity markets

Quick take: U.S. equities trended higher last week, with nine of 11 S&P 500 sectors advancing. We retain our "glass half-full" orientation for equity performance looking toward year-end and into 2022, though we anticipate returns to be more subdued compared to those experienced so far in 2021.

Our view: Rising revenue and earnings, moderate inflation and relatively low interest rates support our positive bias. We expect elevated volatility until the impacts of the Delta variant, inflation and looming monetary and fiscal policy changes become better known.

Third quarter sales and revenue reports are trending largely in line with expectations. While early, with just 8 percent of S&P 500 companies having released results as of Friday's close, sales and earnings are trending up roughly 13 and 40 percent, respectively, over year-ago levels, according to Bloomberg. Expectations heading into the quarter were for revenue to increase 15 percent with earnings advancing 27 percent, according to FactSet Research Systems. Another 13 percent of S&P 500 companies are slated to release results this week.

Financials are exhibiting out-sized earnings strength, aided by loan loss releases. The Financials sector is posting yearover-year earnings growth of nearly 44 percent, with 21 percent of companies within the sector having released results. Loan loss reserve releases are driving this growth. The release of loan loss reserves, which help lenders control for the risk that loans will not be repaid, is consistent with economic improvement. Many money center banks trended lower on the favorable earnings releases, perhaps suggesting that prices already reflect the positive reports. As of Friday's close, Financials is the second-best performing sector year-to-date, up 33.9 percent versus the 19.0 percent gain of the S&P 500. Emphasis is increasingly shifting toward loan growth, net interest income and expense control as primary drivers of share prices in subsequent quarters.

Broad market valuation remains within a "zone of okay," bolstered by rising earnings. Consensus estimates for the S&P 500 in 2021 and 2022 continue to inch higher, currently at $202 and $220 per share, respectively, according to Bloomberg, FactSet and S&P Global. At these levels, the index trades at approximately 22 times the 2021 estimate and 20 times the 2022 estimate, levels we consider elevated yet short of extremes.

Bond markets

Quick take: Long-term Treasury yields took a breather from their recent upward trend. The yield edge for corporate and municipal bonds over Treasuries remains low and stable, supporting high bond prices. The Federal Reserve (Fed) released minutes from its September meeting that indicated plans to announce a schedule for reducing bond purchases at the November meeting.

Our view: We prefer increasing income in bond portfolios through allocations to high yield corporate and municipal bonds, bank loans and mortgages not backed by the government. While the additional yield over Treasuries on these bonds are low compared to the past, we believe issuers' strong credit fundamentals, from the low cost of servicing debt and high cash balances, will support bond prices. Higher-quality bonds remain an important component of diversified portfolios and may become more attractive if Treasury yields continue to rise.

The market expects the Fed to announce a plan to reduce asset purchases at its next meeting in November, but their response to high inflation remains in question. The Fed's September meeting minutes acknowledged inflation is more persistent than members expected, but officials hold a wide range of preferred policy reactions. Market expectations for a rate hike next year increased, which pushed short-term Treasury yields higher, while a resulting reduction in long-term growth expectations caused a fall in long-term yields. We believe low yields limit the return outlook on Treasuries, and bond prices are facing additional headwinds from the Fed reducing bond purchases and possibly increasing rates as soon as next year. Our preference for riskier bonds will shift if Treasury yields extend their rise, improving their return outlook.

Riskier bonds continue to outperform Treasuries. While the additional yield on risky bonds over Treasuries is low and limits the potential for further price gains, the extra income these bonds pay investors has aided in their outperformance. We prefer allocations to high yield corporate and municipal bonds, bank loans and mortgages not backed by the government to increase coupon income in bond portfolios. Favorable demand for these bonds, infrequent defaults and limited sensitivity to Treasury yield changes supports their return outlook.

[ 3 ] Important disclosures provided on page 4.

Real assets

Quick take: Real assets performed well last week as inflation data rose again. Supply constraints supported prices for oil and metals as well as industrial real estate.

Our view: Rising inflation and solid growth are supporting real asset prices.

Real Estate beat the S&P 500 by 2 percent last week. Industrial properties performed well given relatively tight space and growing retail sales. Weaker services spending was reflected in softer prices for leisure properties.

Crude oil prices rose by 3.7 percent last week to the highest levels since 2014. The market again shrugged off an increase in domestic crude inventories, with the supply of refined products remaining tight. Investors appear concerned major oil exporters may be unable to increase supplies sufficiently to meet rising demand as the global economy recovers from the pandemic.

Copper prices rose 10 percent during the week and are now up 34 percent on the year. Inventories remain low and energy shortages in China are limiting smelting capacity, further restraining supplies.

This information represents the opinion of U.S. Bank Wealth Management. The views are subject to change at any time based on market or other conditions and are current as of the date indicated on the materials. This is not intended to be a forecast of future events or guarantee of future results. It is not intended to provide specific advice or to be construed as an offering of securities or recommendation to invest. Not for use as a primary basis of investment decisions. Not to be construed to meet the needs of any particular investor. Not a representation or solicitation or an offer to sell/buy any security. Investors should consult with their investment professional for advice concerning their particular situation. The factual information provided has been obtained from sources believed to be reliable, but is not guaranteed as to accuracy or completeness. U.S. Bank is not affiliated or associated with any organizations mentioned.

Based on our strategic approach to creating diversified portfolios, guidelines are in place concerning the construction of portfolios and how investments should be allocated to specific asset classes based on client goals, objectives and tolerance for risk. Not all recommended asset classes will be suitable for every portfolio. Diversification and asset allocation do not guarantee returns or protect against losses.

Past performance is no guarantee of future results. All performance data, while obtained from sources deemed to be reliable, are not guaranteed for accuracy. Indexes shown are unmanaged and are not available for direct investment. The S&P 500 Index consists of 500 widely traded stocks that are considered to represent the performance of the U.S. stock market in general. The Consumer Price Index is a measure that examines the weighted average of prices of a basket of consumer goods and services, such as transportation, food and medical care. It is one of the most frequently used statistics for identifying periods of inflation or deflation. The Producer Price Index is a group of indexes that calculates and represents the average movement in selling prices from domestic production over time. It is a measure of inflation based on input costs to producers.

Equity securities are subject to stock market fluctuations that occur in response to economic and business developments. International investing involves special risks, including foreign taxation, currency risks, risks associated with possible differences in financial standards and other risks associated with future political and economic developments. Investing in emerging markets may involve greater risks than investing in more developed countries. In addition, concentration of investments in a single region may result in greater volatility. Investing in fixed income securities are subject to various risks, including changes in interest rates, credit quality, market valuations, liquidity, prepayments, early redemption, corporate events, tax ramifications and other factors. Investment in debt securities typically decrease in value when interest rates rise. This risk is usually greater for longer-term debt securities. Investments in lower-rated and non-rated securities present a greater risk of loss to principal and interest than higher-rated securities. Investments in high yield bonds offer the potential for high current income and attractive total return, but involve certain risks. Changes in economic conditions or other circumstances may adversely affect a bond issuer's ability to make principal and interest payments. The municipal bond market is volatile and can be significantly affected by adverse tax, legislative or political changes and the financial condition of the issues of municipal securities. Interest rate increases can cause the price of a bond to decrease. Income on municipal bonds is free from federal taxes, but may be subject to the federal alternative minimum tax (AMT), state and local taxes. There are special risks associated with investments in real assets such as commodities and real estate securities. For commodities, risks may include market price fluctuations, regulatory changes, interest rate changes, credit risk, economic changes and the impact of adverse political or financial factors. Investments in real estate securities can be subject to fluctuations in the value of the underlying properties, the effect of economic conditions on real estate values, changes in interest rates and risks related to renting properties (such as rental defaults).

[ 4 ] ?2021 U.S. Bank.

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