On the Radar

City National Rochdale, | Oct. 09, 2018

FAQs on the Markets and Economy

Is City National Rochdale’s investment outlook still positive?

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.

Still, we believe investors should prepare for more moderate returns in the months ahead and perhaps greater volatility. Patience and discipline will be more important than ever.

The investment landscape is growing more challenging as investors adjust to more typical late-stage expansion conditions of higher inflation, rising interest rates, and less accommodative monetary policy.

Meanwhile, concerns over global growth, rising trade tensions, midterm elections, and other geopolitical risks, mean markets will likely continue to be subject to periodic swings in sentiment and potential pullbacks.

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.

The meeting held few surprises, but contained important information that was well anticipated by the markets. The Fed raised the federal funds rate 25 bps to the median level of 2.125%, which makes it the third hike this year and the eighth in this cycle.

The Fed did not alter their guidance for future hikes: they expect one more increase this December, three increases in 2019, one increase in 2020, and no movement in interest rates in 2021 (chart). With inflation contained around the 2.0% level, despite the very low level of unemployment, the Fed has been able to fulfill its plan to gradually return interest rates to a more “normal” level.

The Fed is trying to strike a delicate balance as they raise interest rates enough to prevent inflation from taking off, but at the same time, they do not want to raise them too much to choke off the economic expansion.

Strength in corporate earnings has been a key source of support for the stock market, helping to some extent offset worries over other issues such as trade tensions and Fed tightening.

The market will be looking for reconfirmation of earnings strength in the Q3 earnings reporting season, which has just gotten underway. Overall earnings growth reached its highest level in almost eight years in each of the last two quarters.

The pace of growth should subside from 25% in Q2 to 19% in Q3. Solid economic growth provides a supportive backdrop for revenues to grow an estimated 6.5% to 7%.

We will be looking at company comments and results to assess the effects of the dollar’s strength, rising interest rates, trade tensions, slower global demand, and whether companies are starting to feel the pinch of cyclical cost inflation.

Yes, the strength in the labor market has created significant wealth for households allowing them to purchase more goods and services. The tax cut has helped too.

Since consumption accounts for more than 2/3 of GDP, this has given a boost to overall economic growth. The Fed has upped their projection of 2018 GDP to 3.1%; last quarter, it was just 2.8%.

Per capita disposable income (chart) has been on an upward trajectory for more than five years, following the tax hike in early 2013 that caused a downward shift in real disposable income and a drop in the saving rate too.

2.5 million people have been added to the payrolls in the past year ,and personal income is up 4.7% for the same period of time. This is all helping to pave the way for stronger consumer spending.

The new agreement is called the United States-Mexico-Canada Agreement (USMCA). The deal is subject to approval by the three parties, and in the case of the U.S., a Congressional vote. The most significant changes include new rules-of-origin provisions related to the percentage of imports permitted for goods produced within the region. Additionally, it includes better enforcement provisions and updated rules specifically pertaining to digital transactions and intellectual property intended to modernize the agreement.

Overall, though, the new trade deal represents relatively minor changes to the 20-year trade accord and won’t in itself have much impact on the U.S. economy. The most significant benefit is that it removes uncertainty about the Trump administration’s trade policies, helping business, and particularly automakers, move forward with factory investments, and ensures that potential significant economic fallout from supply chain disruptions is avoided.

It also offers encouragement that other trade disputes with the Trump administration can be resolved without significant economic consequences. Along with the deal recently made with South Korea, it provides another example of President Trump backing down from his hard-line protectionist threats in return for modest concessions that allow him to claim victory.

Predicting political ramifications is an error-prone exercise, but with leadership in the House and/or Senate possibly up for grabs, 36 governor seats at stake, and the probable swing of leadership of some state legislatures, the composition of the future federal and state legislative bodies will unavoidably influence future policy and fiscal decisions. Here are three important issues:

Education: If recent teacher revolts are any indication, further pressure to enhance funding of education will likely occur and could impact the structure of state funding regimes for K-12 education (see chart).

Health care: This is a perennial policy risk that continues to garner significant attention. Health care cost are expected to grow at nearly 6.0% through 2026, which is a faster pace than growth of tax revenues. The federal and state governments will have to employ several options, like identifying new funding sources, restructuring, or cutting benefits.

Infrastructure: Almost everywhere, there is a need for an upgrade. The problem lies in finding a source of revenue. State and local governments bear the majority of that spending, often with debt issuance.

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Important Disclosures

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.

Certain statements contained herein may constitute projections, forecasts, and other forward-looking statements, which do not reflect actual results and are based primarily upon a hypothetical set of assumptions applied to certain historical financial information. 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. Any opinions, projections, forecasts, and forward-looking statements presented herein are valid as of the date of this document and are subject to change. There are inherent risks with equity investing. These include, but are not limited to, stock market, manager, or investment style risks. Stock markets tend to move in cycles, with periods of rising prices and periods of falling prices.

Investing in international markets carries risks such as currency fluctuation, regulatory risks, and 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.

There are inherent risks with fixed income investing. These may include, but are not limited to, interest rate, call, credit, market, inflation, government policy, liquidity, or junk bond risks. When interest rates rise, bond prices fall. This risk is heightened with investments in longer-duration fixed income securities and during periods when prevailing interest rates are low or negative.

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.

The yields and market values of municipal securities may be more affected by changes in tax rates and policies than similar income-bearing taxable securities. Certain investors’ incomes may be subject to the federal Alternative Minimum Tax (AMT), and taxable gains are also possible.

Investments in the municipal securities of a particular state or territory may be subject to the risk that changes in the economic conditions of that state or territory will negatively impact performance. These events may include severe financial difficulties and continued budget deficits, economic or political policy changes, tax base erosion, state constitutional limits on tax increases, and changes in the credit ratings.

Investments in emerging markets bonds may be substantially more volatile, and substantially less liquid, than the bonds of governments, government agencies, and government-owned corporations located in more-developed foreign markets.

Indices are unmanaged and one cannot invest directly in an index. Index returns do not reflect a deduction for fees or expenses.

Returns include the reinvestment of interest and dividends.

Investing involves risk, including the loss of principal.

As with any investment strategy, there is no guarantee that investment objectives will be met, and investors may lose money.

Past performance is no guarantee of future performance.

Index Definitions

The Standard & Poor’s 500 Index (S&P 500) is a market capitalization-weighted index of 500 common stocks chosen for market size, liquidity, and industry group representation to represent U.S. equity performance.

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