FAQs on the Markets and Economy
Why is City National Rochdale bullish on EM Asia equities?
We are seeing early signs of improvement in Emerging Asia economic data, and policy across the region is likely to turn more supportive this year through fiscal and monetary stimulus. Meanwhile, recent developments in U.S.-China trade negotiations have offered encouragement that a more damaging trade war will be avoided.
The Fed’s recent dovish turn is also a positive, helping take pressure off EM central bankers, strengthening Asian currencies and reducing costs on emerging market companies with dollar-denominated debt.
For investors, EM Asia boasts a much more superior growth and valuation profile, particularly versus Europe and other non-U.S. developed markets. Even after this year’s rally, Emerging Asia equity valuations are still attractive, both on a historical basis and relative to other geographies.
Longer term, our proprietary 4Ps Framework analysis continues to indicate the investment opportunity is compelling. The region’s strong growth outlook remains resilient, supported by rising income growth, robust demographic and urbanization trends, and high investment rates. Our focus is on sectors and companies in Emerging Asian economies that should benefit from these structural tailwinds. Read more about the 4Ps framework in our Emerging Markets White Paper available online.
Why is City National Rochdale bearish on non-U.S. developed markets?
We think the YTD rebound in non-U.S. developed market equities has gotten ahead of fundamentals, providing a good opening for investors to sell and reallocate to more attractive global opportunities in EM Asia equities. Euro economic data points to continued weakness, with more exposure to trade uncertainty and slower global demand. Political risk is high and we remain skeptical of the ECB’s ability to boost growth prospects.
Japan’s economic activity also continues to be sluggish despite supportive policy stimulus. As a result, earnings expectations are likely to be revised downward in the quarters ahead. Valuations, meanwhile, are not cheap on a historical basis or relative to other markets. In fact, Euro valuations are just as pricy as their U.S. equities on a sector-adjusted basis.
In an environment of low global GDP and inflation, higher exposure to cyclically oriented sectors makes it unlikely non-U.S. developed markets will outperform in the near term. Longer-term, our 4Ps framework analysis indicates the outlook for non-U.S. developed economies remains hamstrung by structural barriers to growth including an aging population, declining productivity, high unemployment and diminished global competitiveness.
How good was the recent labor report?
Hiring rebounded strongly in March, increasing by 196,000. It was a marked increase above the February increase that was initially reported as 20,000, since revised to 33,000. This eased the fears of some that thought economic growth was cooling.
Severe weather has helped cause wide fluctuations in the monthly reporting. The labor market is strong. The average monthly gain in payrolls for this year is 180,000. This is close to the long-term average of this expansion, which is 190,000 (chart).
The unemployment rate is at 3.8%, just slightly above the cycle low of 3.7% registered this past September. It is getting harder for employers to find qualified workers. Wages increased 3.2% in the past year, well above the inflation rate of 1.8%.
What is the current thinking about the recent yield curve inversion?
The slope of the yield curve inverted in March for a few days when the yield of the 10-year treasury note fell below that of the three-month treasury bill (chart).
This is often used as an indicator for a recession. An inversion of the yield curve has preceded each recession since the 1960s.
Economists are beginning to believe that too much emphasis is being placed on the current shape of the yield curve since it has been distorted by extremely accommodative monetary policy which includes quantitative easing, which affected longer-term interest rates.
Another metric might be the credit curve, the yield differential between short-term and long-term corporate debt. Here, the curve is at 120 bps, well above the average of 80 bps since 2000. The last time this inverted was in March 2008, about five months before the financial crisis. There is a lot of academic research being done on this to gain a better understanding.
How has the recent improvement in various indicators affected the market’s perception of future Fed action?
It has been a wild ride for this metric. Back in the autumn, when the economic outlook was very strong (unemployment at cycle low of 4.7% and PMI manufacturing at cycle high of 60.8), the stock market hit an all-time high. The federal funds futures market was expecting at least two rate hikes by the Fed in 2019 (chart).
Now, with the stock market within spitting distance of the Sept. 20, 2018 highs, the federal funds futures market does not share that enthusiasm. Following about five months of trading down in yield, this metric has an implied probability of a chance of an interest rate cut this year.
Although much of the domestic economy is close to what it was six months ago, there are some parts that are not as strong. The most notable change is the Federal Reserve’s outlook. The Fed is no longer expecting to hike interest rates twice this year, like they did back then. Now, they are on hold for the remainder of the year. The federal funds futures market is representing the new tone.
What is City National Rochdale’s investment outlook for 2019?
Given our positive assessment of the fundamental backdrop, we remain bullish on equities in general for 2019 and continue to see attractive prospects in the opportunistic fixed income class. Still, we believe investors should prepare for more moderate returns in the year ahead and continued volatility.
The investment landscape has grown 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, trade tensions 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. Our equity and fixed income research teams have made deliberate risk-mitigating changes to help fortify client portfolios against the type of turbulence we have recently experienced while leaving them well-positioned to take advantage of opportunities, should they present themselves.