FAQs on the Markets and Economy
Has City National Rochdale’s outlook changed for 2018?
Based on our outlook for solid economic growth and improving corporate earnings, we remain bullish on equities in general and continue to see attractive prospects in the opportunistic fixed income class. Bear markets outside recessions are rare.
However, the investment landscape is growing more challenging as investors adjust to a more typical late-stage expansion environment of higher inflation, rising interest rates and less accommodative monetary policy.
None of this means there are not more worthwhile gains ahead for investors, but it does highlight the value of active management and the need for investors to become more selective.
We actively manage portfolios to be aware of where we are in the cycle, to take advantage of opportunities as they arise and to be on alert if conditions deteriorate.
Recently, we have moved up in quality in both our fixed income and equity portfolios to prepare for the volatility we have been experiencing. At the same time, there are pockets of value in the market, and we seek to selectively take advantage of those opportunities.
What is the current thinking of the Fed?
The Fed has a much more upbeat view of the economy. It increased its assessment of the economy from “modest to moderate” to “moderately.” It may not sound like much, but for the Fed, it is a significant change in its outlook. It has indicated that manufacturing has “shifted into higher gear” and that business activity remains robust. That said, it is concerned about international trade policy, and consumer spending is a bit soft.
The Fed remains committed to a gradual path of interest increases. Despite the firming of inflation in Q1, it sees no need to raise rates at a faster pace than its current plan, which is a total of three increases this year.
Although economic fundamentals have not changed recently, despite the Fed’s recent comments, fed funds futures have fallen recently. This is mostly in response to the Italian political crisis, as some investors are afraid of “euro breakup” coming back into the news. That has put fear in the market (Italian yields have spiked, see question #3) and fear of slower global economic growth.
Why has the yield of Italian bonds gapped up so much?
The yield on the 10-year Italian sovereign debt hit a peak of 3.15% on May 29 and ended the month at 2.77%. That is significantly higher than the April average yield of 1.77% (chart).
What is currently happening in Italy is a political crisis, not an economic crisis like the 2010-12 euro crisis that centered around Greece. Italy had an election in early March, and a majority was not elected. This led to months of jockeying to form a coalition government, which was recently formed by two rival populist parties from different ends of the political spectrum. What they had in common was being a euroskeptic.
They proposed a finance minister, Paolo Savona, who co-authored a guide to leaving the eurozone. This didn’t sit well with Italy’s president, Sergio Mattarella, who wants to form a new government with Carlo Cottarelli, a former IMF official and is pro-euro. Mattarella believes the coalition government would abandon the euro without sufficient public debate and posed a risk “for Italian families and their savings.”
Since then, there has been significant political fighting concerning the financial markets.
Are rising trade tensions a concern?
The Trump administration has now followed up on steel and aluminum tariffs against China by announcing it will also let exemptions for the EU, Canada, and Mexico expire. All four have threatened to retaliate.
Relative to the overall size of U.S. trade and underlying GDP, the near-term costs of recent U.S. trade actions look manageable. However, the longer-term costs of potential trade wars are greater. The Dallas Fed estimates that a trade war with the EU and China would reduce U.S. economic growth by nearly 3.5% in the long run.
Our sense is that the president’s actions are most likely being used as a negotiating approach. But if more severe and provocative protectionism is forthcoming, it would be a serious concern for global economic performance and financial markets.
Trade tensions are unlikely to be resolved soon, and uncertainty driven by headlines may weigh on investors and the economy. Still, for now we continue to believe fallout will be relatively contained and that the risk of escalation to a full-blown trade war remains low.
Is City National Rochdale’s outlook for Emerging Asia equities still positive?
Emerging Asia equities have underperformed overall EM (and Developed Markets) this year, as oil and commodity prices have rallied and tariff‐war concerns have raised uncertainty levels.
Over the near term, we expect policy uncertainties to prevail; they may continue to hurt EM Asia market sentiment.
However, our long‐term outlook remains supported by positive fundamentals, including demography, income growth, urbanization trends, and saving/investment behavioral characteristics. We continue to focus on sectors and companies that should benefit from these long-term structural tailwinds.
Moreover, with the recent market pullback, Emerging Asia equity valuations look increasingly favorable, both on a long-term historical basis and relative to other geographies.