FAQs on the Markets and Economy
What caused the current sell-off in the market?
The market appears to have been caught off guard by the escalation and severity of trade tensions between the U.S. and China over the past week. The Trump administration’s surprise announcement last week of a 10% tariff on $325 billion in Chinese goods was quickly met this week by China’s suspension of U.S. agricultural purchases and the apparent decision by authorities to stop supporting the yuan. This in turn led to an announcement by the Treasury Department that it would designate China as a currency “manipulator”.
Throughout the recent rally, we have thought investors were too confident over trade progress and did not view recent developments as a game changer on their own. While an eventual trade deal between the U.S. and China remains possible, both sides continue to be far apart on key issues, and we believe there will likely be more pain before any agreement is reached. In the meantime, further downside is still possible as investors adjust to this reality, and we are recommending a more cautious approach in the near term. Still, we do not think it’s time to step away from the market. Over the past year and half, we have seen several sizeable pullbacks in stock prices related to policy uncertainty, and the driving force behind each rebound has been the same: an expanding economy, earnings growth, and low interest rates.
This is what late-cycle investing looks like. By focusing on high-quality large cap U.S. stocks , selected credit areas, and alternative investments, we have positioned our portfolios to help withstand volatility and minimize risk, yet continue to participate in future gains.
What is the impact of the sell-off on the U.S.? What about the rest of the world?
Trade tensions have been running for over a year now, and uncertainty surrounding the issue is weighing on overall global growth and corporate profits. The IMF is now forecasting the global GDP will slow in 2019 to the weakest rate in a decade — before picking up modestly in 2020. However, the projected pick-up in global growth next year is precarious, relying on progress in resolving the U.S.-China trade differences, among other policy issues.
Compared to other major economies, such as Europe with its higher exposures to international demand and trade, the U.S. economy appears to be in good shape. To a large degree, the U.S. is relatively insulated from global headwinds, getting most of its growth from domestic demand, which remains strong. Exports make up only about 12% of U.S. GDP, and trade with China specifically accounts for only 1%. As a result, we estimate that the impact from current and potential tariffs will shave only about 0.35% off U.S. growth.
Our base case expectation for modest profit growth of 2-4% has also incorporated worst case assumptions of further escalation in tensions with China, and our portfolios have stayed away from export-sensitive sectors of the economy, as well as global regions like Europe that are more exposed to trade disruptions and global weakness.
What are the risks?
We are in a period of high political uncertainty both at home and abroad. From continuing trade tensions to Brexit to the path of future Fed rate hikes, the list of risks is not short and remains the biggest threat to the global economic outlook.
At the moment, the U.S. economy remains strong enough to withstand some global headwinds. Manufacturing has weakened over the course of the year, and business sentiment has waned somewhat, yet the broader economy has been mostly resilient so far to rising trade uncertainties. Importantly, the labor market remains healthy, and consumers are confident and spending (see chart).
Still, U.S. growth is slowing, and the business cycle is aging, leaving a smaller margin for error on the policy front. The Trump administration’s threats to broaden its disputes with other trade partners on key sectors like autos is our primary risk and one we are closely monitoring, as it could threaten the job growth and confidence that has underpinned the long running expansion.
Are we making any changes to our portfolios?
No, there is no change to the Late-Cycle Playbook. We don’t think the bull market is finished just yet, but investors should brace themselves for lower market returns, more volatility and bigger tail risks.
City National Rochdale’s Late-Cycle Playbook involves taking deliberate and measured steps to improve the quality, yield and sources of diversification in portfolios we manage.
We continue to focus on higher-quality and dividend-paying domestic companies, and we have recently lowered exposure to MidSmall Cap equities, which tend to perform best at the beginning of economic expansions and are more vulnerable in a market downturn. At the same time, we are underweight cyclical and export-oriented sectors most affected by trade and global headwinds, with notable underweights in commodities, machinery, tech hardware and semiconductors.
In our fixed income portfolios, we think opportunistic income still offers attractive opportunities, but have nudged quality higher across our various strategies in response to late-cycle indicators and prefer asset classes with seniority in the capital structure at current market valuations. Given recent concerns, we have also reduced exposure to local currency in favor of USD bonds.
More changes are likely to come as we follow our Late-Cycle Playbook and respond to the maturing nature of the cycle.