On the Radar

City National Rochdale, | Dec. 17, 2019

FAQs on the Markets and Economy

What does impeachment mean for the market?

U.S. constitutional clashes like impeachment are rare events, with market outcomes too context-specific to draw definitive conclusions regarding current developments. However, going by the limited history we have, market reaction over the long term seems more linked to economic fundamentals.

Although the S&P 500 fell almost 50% through the Watergate affair and its aftermath, this decline reflected much more than concerns surrounding the fate of the Nixon administration. The country was slipping into recession, hit by an oil embargo and spiking inflation. In contrast, with the U.S. economy growing well over 4%, earnings strong and moderate inflation, President Clinton’s troubles did little to blunt the bull market of the 1990s.

We think the same is true today. Rather than political turmoil in Washington, recent market movements appear driven by developments in trade negotiations, as well as incoming data on the economy and corporate profits.

Nevertheless, it would be complacent to think that potential impact from impeachment will be limited. At a minimum, it adds another layer of uncertainty to the economic backdrop and should contribute to further market volatility ahead.

Our late cycle playbook has positioned us well for an environment of heightened policy and political uncertainty, and we will be closely monitoring developments for signs that this uncertainty is bleeding into the broad economy and affecting consumer confidence. If so, we will act to further de-risk our portfolios as conditions warrant.

The Federal funds rate was maintained at 1.625%, as widely expected, and they plan no changes in 2020. Down the road, the Fed plans a single hike of 25 bps in 2021 and another in 2022.


Our outlook is a little different than the Fed’s. We believe the economy is in the later stage of this expansion, with slowing but sustainable growth. City National Rochdale expects 1 – 2 cuts in the Federal funds rate in 2020, which is close to market consensus, and different from the Fed.

U.S. and Chinese officials have announced a limited preliminary agreement to halt the trade war. While this signals a welcome détente in what’s been an increasingly harmful confrontation between the nations, a number of details remain unclear and the deal does not fully address many of the fundamental issues that sparked the trade war in the first place.

For now, the agreement halts any additional new U.S. tariffs, while scaling back by half a separate tranche imposed in September. On its own, that would reduce the average tariff on Chinese imports from 17% to 15.5% – still roughly double the average tariff rate at the beginning of 2019.

In exchange, Chinese officials have pledged to substantially increase its imports of U.S. goods and services by at least $200 billion over the next two years, including $40 billion to $50 billion in farm commitments. In addition, China has agreed to make some structural changes in how it deals with intellectual property rights and its practice of forcing technology transfers of American companies in order to access the Chinese market.

By removing the threat of new tariffs, reducing some uncertainty and providing a small boost to exports, the deal is certainly a near-term positive for the U.S. economy as well the global outlook, which has struggled against rising trade tensions.

Equity markets have rallied to record highs, in part on rising hopes that the U.S. and China are making progress in their trade dispute. However, with many core issues having been pushed off to “Phase 2” negotiations, we suspect that friction between the two nations will be a continuing source of economic uncertainty and market volatility in 2020. We also remain concerned the Trump administration may now take the opportunity to turn its attention to other key trading partners and economically sensitive sectors, such as autos.

Our asset allocation and investment strategies are positioned to take this uncertainty into account. We are overweight U.S. equities and underweight international markets, particularly those of other developed economies, which are more affected by trade disruptions. Likewise, our domestic equity strategy has little exposure to sectors of the economy that have the greater potential to be impacted, such as autos and semiconductors.

No. The Fed is very clear about that. Although both grow the Fed’s balance sheet, the impact is very different.

Quantitative easing (QE) is designed to stimulate economic growth. With QE, the Fed creates reserves and buys longer dated treasury securities from banks. This has two goals: it pushes down longer-term yields, making borrowing more attractive and secondly it provides a great deal of excess reserves in the banking system to lend out.

The Fed’s current strategy is designed to alleviate stresses in the repurchase agreement market. The Fed is creating reserves and is buying treasury bills ($60 billion per month) to provide reserves to help with the financing of Wall Street’s holdings.

Although the Fed’s balance sheet is growing, as it did during QE, there is very little growth to banking’s excess reserves, which is needed to stimulate the economy.

Labor market conditions continue to be strong. The unemployment rate fell back down to 3.5%, matching a 50-year low. Non-farm payrolls jumped 266,000 and the previous two months were revised up by 41,000. That means there were 307,000 more workers in November than reported in October. That is strong growth compared to the average gain of the previous 12-months of 178,000.

America’s job engine is on an upward trend. This 266,000 gain compares favorably to the monthly average of the previous three months of 189,000 and the six months of 162,000. This is a substantial achievement for an economy in its eleventh year.

This strong demand for workers has drawn many back into the workforce. Employers have broadened their scope of employees by recruiting workers beyond the age of 65, those with disabilities and those with criminal records. This has lifted the labor force participation rate to 63.2%, from the lows of 62.4% in 2015.

Given our continued positive assessment of the fundamental backdrop, we remain positive on U.S. equities in general and continue to see attractive prospects in the opportunistic fixed income class.

Still, downside risks have increased somewhat, and the investment landscape is growing more challenging.

Late-cycle conditions of slowing growth and greater vulnerability to policy missteps will require investors to change their approach and be more selective in their portfolios.

None of this means there are not more opportunities ahead for investors, but gains are likely to be more muted. At the same time, concerns over global growth, trade tensions and the path of interest rates mean markets will likely continue to be subject to periodic swings in sentiment and potential pullbacks.

Our equity and fixed income research teams have made deliberate risk-mitigating changes to help fortify client portfolios against the type of market turbulence we have recently experienced, while leaving them well-positioned to take advantage of opportunities that present themselves.

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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.

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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