Market and economic update - U.S. Bank

Market analysis

November 8, 2021

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.

At a glance

A strong jobs report, a constructive Federal Reserve meeting and solid earnings reports pushed the U.S. stock markets to new all-time highs.

10.6%

The performance of the smallcompany-oriented Russell 2000 Index so far in the fourth quarter, outpacing the 9.1 percent return of the S&P 500.

TERM OF THE WEEK

Sector rotation ? The movement of money invested in stocks from one industry to another as investors anticipate the next stage of the economic cycle.

"The fundamentals remain intact for still higher equity prices: Earnings are rising, inflation is moderate, interest rates remain low and valuations are elevated yet short of extremes. However, investors appear to be modestly shifting toward laggards with compelling growth profiles. In particular, Technology and small- and mid-sized companies have recently outperformed."

- Terry Sandven, Portfolio Manager, Chief Equity 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

Equity markets

Quick take: The U.S. saw improvement in the labor market and business activity, and the U.S. House passed the bi-partisan infrastructure bill. China business activity shows smaller private sector firms outperforming large state-owned peers as its economy broadly slows.

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

Following Democratic losses in key state races, the U.S. House rushed the infrastructure bill to President Biden's desk. The $1 trillion bill includes funding for broadband, highways, bridges and railways and is the largest infrastructure spending program since President Eisenhower's interstate highway program. Attention will turn to the "Build Back Better" reconciliation bill, which is currently undergoing cost and revenue analysis by the Congressional Budget Office.

A solid October jobs report alleviated some concerns, but total employment and the number of people working or seeking work remain well below pre-pandemic levels. Nonfarm payrolls added 531,000 jobs in October and 235,000 jobs in revisions to prior months. Declining COVID-19, a largely successful back-to-school effort and emergency pandemic unemployment programs drove the improvements. Gains in average hourly earnings of 4.9 percent over the past year should induce further job market gains and are likely helping consumers weather recent inflation.

Institute for Supply Management (ISM) surveys of business activity show strong acceleration of services in October, with manufacturing activity decelerating slightly but remaining at a high level. ISM noted that demand shows no sign of slowing, while inventories and backlogs remain tight due to supply chain issues. Overall, this highlights a transition from greater goods consumption during the pandemic back toward services consumption -- another step toward normalization.

China's business activity has diverged as the country faces economic and pandemic-related challenges. State-owned and larger Chinese companies are seeing continuing deceleration in activity, while smaller private-sector firms are showing some improvement -- especially services. Continuing services improvement depends on coronavirus containment, which for now appears successful.

[ 2 ] Important disclosures provided on page 4.

Quick take: The popular broad-based U.S. indices continue to move higher as the third quarter earnings season winds down and investor focus begins to shift toward holiday spending patterns.

Our view: Rising revenue and earnings, moderate inflation and relatively low interest rates support our positive bias looking toward year-end and into 2022. We expect elevated volatility until the impacts of the Delta variant, inflation and duration of supply chain dislocations become better known.

Performance remains superb, broad-based and consistent with economic recovery. The S&P 500 ended last Friday up 25.1 percent for the year. All 11 sectors are in positive territory, and nine are up 17 percent or more. The two lagging sectors, Consumer Staples and Utilities, are up a respectable 9.0 percent and 7.0 percent. Favorable broad-based performance is consistent with periods of economic growth.

Sector rotation appears to be broadening out. The 25.1 percent year-to-date return of the S&P 500 is more than twice the longer-term historical annual average of approximately 10.5 percent, suggesting that a portion of the companies within the best-performing sectors may be priced to perfection. The fundamentals remain intact for still higher equity prices: Earnings are rising, inflation is moderate, interest rates remain low and valuations are short of extremes. However, investors appear to be modestly shifting toward laggards with compelling growth profiles. In particular, Technology and small- and midsized companies have recently outperformed. The Technologyoriented NASDAQ Composite (up 10.5 percent) and smaller company-oriented Russell 2000 Index (10.6 percent) are leading fourth quarter performance, versus the large-company S&P 500 (9.1 percent) and cyclical-oriented Dow Jones Industrials (7.3 percent).

Earnings are exceeding expectations, providing valuation support while serving as the basis for stocks to trend higher. Roughly 89 percent of S&P 500 companies have released third quarter results, according to Bloomberg. Sales and earnings are up approximately 19 percent and 41 percent over year-ago levels, respectively, both above expectations. Estimates for 2021 and 2022 are roughly $206 and $221 per share, respectively, according to Bloomberg, FactSet and S&P Global. At present, the S&P 500 trades at approximately 23 times 2021 estimates and 21 times 2022 estimates, both well below dotcom era extremes of nearly 30 times.

Bond markets

Quick take: Bond prices extended their recent rise last week, with Treasury yields falling on dampened rate hike expectations. The Federal Reserve (Fed) met investor expectations on Wednesday by announcing a plan to gradually reduce bond purchases and expressing a patient approach to determining interest rate policy next year.

Our view: We favor the return potential on lower-quality, higheryielding bonds relative to higher-quality bonds. High yield corporate and municipal bonds, bank loans and mortgages not backed by the government all offer attractive coupon income considering their strong credit fundamentals. We believe high-quality bonds still belong in portfolios for their ability to diversify equity risk.

The Fed will reduce bond purchases starting this month, but further policy changes will be responsive to changing economic conditions. The Fed is reducing its $120 billion per month purchases of Treasuries and agency mortgage-backed securities by $15 billion per month, starting in November and concluding in June 2022. The Fed's announcement met expectations and investor focus shifted to the outlook for interest rate policy in 2022 and beyond. Fed Chairman Jerome Powell expressed a patient approach to interest rate hikes, and the market responded by slightly reducing its rate hike expectations, which remain ahead of Fed forecasts. Bond yields still indicate relatively aggressive interest rate increases, with almost two rate hikes priced in for 2022, which we see as possible but unlikely at this juncture. Powell's renomination as the Fed's leader remains likely, although uncertainty around President Biden's decision introduces another layer of policy opacity.

Demand for coupon income supports riskier bond prices. Historically low yields (high valuations) across the bond market limit return potential, but increasing coupon income remains an opportunity for outperformance. Investor demand for riskier bonds has been strong relative to new issuance. Diversifying credit risk exposure into high yield corporate and municipal bonds, bank loans and mortgages not backed by the government, is an attractive way to improve portfolio income.

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Real assets

Quick take: Real assets were out of favor again last week, with almost every sector trailing the S&P 500, despite somewhat lower interest rates. Broader commodities declined as the dollar rallied. Real Estate and commodities seem to be stepping back after torrid outperformance so far this year.

Our view: Rebounding demand is supporting most real asset categories. Commodities are generally strong, reflecting still constrained supplies. Real estate benefits from economic reopening, but higher interest rates are a modest headwind.

Real Estate trailed the S&P 500 by 1.5 percent last week, despite a number of companies reporting earnings that beat expectations. Sectors that benefit from economic reopening and the return to office are leading the way, including retail and hospitality properties.

Crude oil prices declined 2.75 percent last week as domestic crude inventories and production rose. As expected, OPEC+ (the Organization of the Petroleum Exporting Countries and 10 oil-producing allies, including Russia) recommitted to its plan of adding 400,000 barrels per day to its production target for the next month. Energy prices remain elevated and balanced between rising demand from economic reopening, tight supplies and the modest pace of output growth.

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 Dow Jones Industrial Average (DJIA) is a price-weighted average of 30 actively traded blue chip stocks and is the most widely used indicator of the overall condition of the U.S. stock market. The Russell 2000 Index measures the performance of the 2,000 smallest companies in the Russell 3000 Index and is representative of the U.S. small capitalization securities market. NASDAQ Composite Index is a market-capitalization weighted average of roughly 5,000 stocks that are electronically traded in the NASDAQ market. The Institute of Supply Management Manufacturing Index, also called the Purchasing Manager's Index, measures manufacturing activity based on a monthly survey, conducted by the Institute for Supply Management, of purchasing managers at more than 300 manufacturing firms.

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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