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.
What did the Fed decide at their recent FOMC meeting?
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.
What’s the takeaway from the recent U.S.-China trade deal?
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.
The Fed is buying treasury bills, is that the same thing as quantitative easing?
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.
What did we learn from the latest labor report?
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.
What is City National Rochdale’s investment outlook?
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.