On the Radar

City National Rochdale, | Dec. 2, 2019

FAQs on the Markets and Economy

What's the latest on U.S.-China trade talks?

Equity markets have continued their rally to record highs, in part, on rising hopes that the U.S. and China are making progress toward a “Phase 1” trade deal.

Although the U.S. is poised to impose an additional 15% tariff on about $156 billion of Chinese products on December 15, it is widely expected that those tariffs will be averted if a deal is struck. However, complicating matters for now are two recently signed bills by President Trump supporting the Hong Kong protestors, as well as China’s continued insistence that rollbacks of previous tariffs be included in any agreement.

While a limited deal between both nations is certainly possible in the near term, and would be a positive for the world economy that has struggled against rising trade tensions, we are somewhat less optimistic than markets are of a major breakthrough.

Developments between the U.S. and China continue to be capricious, highlighting the delicate nature of negotiations. Moreover, as long as core issues remain unaddressed, a re-escalation in tensions remains a distinct possibility and uncertainty will likely continue to weigh over the global outlook in 2020. A recent survey showed that over one-quarter of multinational companies have no contingency plans should the U.S.-China trade war drag on.

At the same time, we remain concerned that the Trump Administration may still turn its attention on other key trading partners and economically sensitive sectors such as autos. In fact, just this Monday, the President announced his intention to impose steel and aluminum tariffs on both Brazil and Argentina.

Our asset allocation and investment strategies are positioned to take this uncertainty into account. We are overweighting U.S. equities and underweighting international markets, particularly those of other developed economies that have been more affected by rising 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.

Although the impeachment proceeding is top news, it does not appear to be having an impact on consumer attitudes.

Consumer sentiment stands at 96.8, which is about the same level it has averaged for almost two years. Households have proved to be very resilient. This index was knocked down twice this year due to large outside forces (federal government shutdown and ramping up of trade war with China) and each time it has roared back (chart).

This index can be volatile on a monthly basis, but on a 12-month moving average, this index stands near the highest levels since the late 1990s.

Consumers have been impressed with the strength of the labor market and the improvement in income. A sub-survey has shown that 54% of households have reported improvement of personal finances over the past year. That is the 10th-highest mark in over 50 years of data.

Claudia Sahm, an economist at the St. Louis Fed, developed a method for the timely determination of a recession. When the three-month average of the unemployment rate rises 0.5% above the low of the previous year, the economy has just or is about to enter a recession. This has happened every time since the 1970s (chart).

This is an important tool that can be used by the Fed to ensure they are easing monetary policy at a time the economy needs it. This is significant since dating of a recession is not known for some time after the recession has started. For example, in the recent recession, the Sahm rule triggered in February 2008. But the economists at the National Bureau of Economic Research, the group that determines the date of a recession, did not officially determine the start of the recession until the end of 2008.

Furthermore, it is easy to calculate and the trend is easily observed.

Q3 GDP was revised from 1.9% to 2.1%. Although slightly more positive, it is still showing a moderate rate of growth. The increase is attributed mostly to growing inventories.

The overall story remains the same of an economy that has been on a decelerating pace over the past year and a half, brought down by trade tensions and global economic slowing. Recently, domestic growth has been under pressure by the GM strike and problems with the Boeing 737 MAX. Fortunately, the GM strike has been resolved and manufacturing should see a bounce back in Q4.

Most importantly, growth in real disposable income remains strong. This a very positive fundamental that is supporting the consumption portion of the economy, which has been the driving force behind recent growth (chart). Fortunately for the U.S. economy, global events appear to have very little impact on consumer attitudes on spending.

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.

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