| Aug. 27, 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, rising trade tensions and other geopolitical risks mean markets will likely continue to be subject to periodic swings in sentiment and potential pullbacks.
This does not mean 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.
Will Emerging Market disorder affect the Fed’s plan to raise interest rates?
We expect the turmoil in Turkey and Venezuela to probably have very little spillover into the United States’ economy and/or markets.
Although the Fed’s statutory objectives are domestically oriented with low and stable domestic unemployment and inflation, there have been times in the past when they have had to adjust monetary policy when global events affected the U.S. economy or markets. For example, in 1998, when Russia defaulted on its domestic debt, that helped foster the near collapse and eventual bailout of hedge fund Long Term Capital Management (LTCM), which helped trigger an almost 20% decline in the S&P 500. The Fed, thinking that market turmoil may cause economic pain, quickly lowered the federal funds rate by 75 basis points.
As it stands now, these two countries’ economic uncertainty appears to be isolated. There does not seem to be any systemic risk, as in past contagions.
With the longest bull market in history, how much longer does it have to run?
No one can predict precisely when a bull market will end, but investors eyeing each turning page of the calendar for an expiration date are making a mistake.
Bull markets tend to end with euphoria and a sense that nothing can go wrong. That’s the opposite of the sentiment today. We have long argued that stocks ultimately follow earnings, and recently earnings growth has been strong. The S&P has just had two consecutive quarters of nearly 25% year-over-year earnings growth.
Meanwhile, annual sales growth, a great barometer of companies’ underlying strength, may top 11% — the strongest since the third quarter of 2011. This is signaling to us that the earnings story is not just about tax cuts and that the economic foundation is supporting demand, allowing companies to grow profits beyond just cost-cutting measures.
The momentum has helped the market climb an admittedly large wall of worry to reach a new high. We expect profits to continue to rise in the quarters ahead and help extend the bull market, but the rate of earnings growth will likely slow, particularly as tax benefits fade, suggesting equity gains may be more moderate.
Why are taxable alternatives becoming favored in short-dated maturities of the municipal bond market?
The yields of short-term municipal bonds (1-3 years) have not kept pace with the rise of comparable Treasury bills and notes. The widening gap has caused municipal valuations to become expensive on a relative basis to Treasury securities.
The retail-dominated municipal bond market psychology could be that the actions of the Fed increasing benchmark rates will lead to parallel shifts across the Treasury curve and thus municipal bond prices will decline. Therefore, excess demand for shorter-term municipal bonds has been driving yields lower in these maturities.
The municipal market has experienced positive YTD capital inflows from investors of approximately $10.7 billion. Moreover, the supply of municipal bonds has declined year-over-year with the total market issuance down roughly 16% from the previous year. Consequently, investor appetite has strengthened.
The distortion in market yields and opportunities to take advantage of relative value asset classes underscore the benefit of active management. At City National Rochdale, we analyze trends within the market and seek opportunities for our clients that best serve their portfolio objectives.
How bad is the inflation problem in Venezuela?
Venezuela doesn’t have inflation, it has hyperinflation. The IMF forecasts inflation will hit 1,000,000% by the end of this year (that is not a typo).
That level of inflation is almost unfathomable. To help illustrate, Bloomberg has an index of the cost of a cup of coffee with milk (chart). A year ago it cost 2,800 bolivars. Today, it costs 2,500,000.
Venezuela, like other countries within OPEC, derives most of its income from oil. However, Venezuela has mismanaged its oil operation and production has declined about 45% since 2015.
To offset that loss of revenue, the government turned to the central bank to print currency. It paid the bills in the short term, but the excessive supply made existing money increasingly worthless. To counter the inflation problem, the government recently devalued the currency by 95%.
Fortunately, the problems seem contained to Venezuela, and there seems to be little contagion risk.
