FAQs on the Markets and Economy
Will the bull market continue in 2019?
The early-year rebound has been encouraging, but also somewhat surprising in its speed and strength. At the same time, valuations are now less compelling than in late 2018. As a result, we remain hesitant to signal the “all clear” and continue to believe the correction process may last several months.
2019’s gains have been the product of an appropriate rebound in sentiment from December’s overly pessimistic outlook for an approaching recession and excessive concern over future rate hikes.
A dovish turn by the Fed, slower but healthy economic data, and better-than-feared corporate earnings results have all provided a more reasonable balance between the present risks and opportunities.
News on the trade front has also been encouraging, though our expectation of a near-term deal being struck between China and the U.S. remains more conservative than the market.
In the months ahead, we expect more upward swings in asset prices when fundamentals improve, as has been the case recently, and downward swings when uncertainty dominates sentiment, as was the case in December. Although the pace of recent market gains is not likely to continue, and another pullback remains possible, we expect that over time equity prices will continue to grind higher in-line with modest corporate profit growth.
What has been the impact of the government shutdown on the economy?
A second shutdown was averted last week, as Congress and the President reached a last-minute agreement to fund the government thru September. While the personal impact from the shutdown on government workers and contractors should not be overlooked, the impact to the overall economy has likely been minimal for now. The CBO estimates the shutdown shaved 0.2% off real GDP growth in Q4 and 0.4% in Q1.
Most of that growth will be recovered. However, continued political uncertainty has dented consumer and business confidence somewhat, and there are indications this is beginning to impact decisions on spending, investment and hiring.
Going forward, the concern is that the recent governmental impasse between political parties may serve as a prelude for bigger fights on more economically important issues down the road. An agreement on the debt ceiling must be reached in March and, even more importantly, a decision must be made on whether to lift budget caps in October. Failure to do the latter will cause a large step-down in government expenditures, which has been adding roughly half a percentage point to GDP growth over the past year.
How strong is the labor market?
It doesn’t get much stronger. Almost all metrics for measuring employment point to strength. For the past 100 consecutive months, there have been increases to payrolls; that longevity of gains is a record that was shattered years ago. The unemployment rate is at 4.0% and has averaged just 3.8% for the last six months; this is among the lowest rate in the 70-year history of this report. Claims for unemployment insurance are near all-time lows, indicating that very few firms are laying off employees (even if there is a temporary downshift in business strength, companies are not laying off employees since they know how hard it is to hire new ones).
There are 7.3 million open positions, an all-time high. What makes this more impressive is that there are only 6.3 million people looking for jobs. For the past ten months, there have been more job openings than workers available to fill them (chart).
Clearly, the labor market remains strong and is poised for continued solid growth. It is a testament to the healthy state of business confidence.
What does the Fed’s slowing of interest rate normalization mean for the economy?
We believe the Fed’s proactive decision to be “patient” in regards to further rate hikes is good news for extending this economic expansion. Too often in history, the Fed does not alter its course of rate increases until a crisis happens (chart). But, there have been a few time (‘80s & ‘90s) that they “read the tea leaves correctly” and decided to cut rates and thus extend the expansion.
We believe this current move is unequivocally good news for the financial markets, particularly risk assets in the short and medium term. As managers, we will stay disciplined with risk assets and are likely to reduce risk if the market goes above our price target. But, we are a ways away from that; our medium-term target currently stands at 2,900 on the S&P 500.
Will the recent slide in revenue collections among high-income states persist, or are they temporary?
State revenues have largely outperformed since the end of 2017, with the Tax Cuts and Jobs Act viewed as a key driver of strong collection activity. The tax law incentivized taxpayers to recognize income earlier, in some cases, to accelerate payments to take advantage of expiring uncapped SALT deductions. However, the timing decisions, while initially beneficial, are suspected to have caused steeper-than-expected declines in personal income (PIT) receipts over the past two months, especially for states dependent on high-income earners.
The recent trends could complicate budget planning for the upcoming FY 2020 if collections do not rebound during the second half of the fiscal year (ending June 30). Both NY and NJ reported PIT and gross receipts tax payments, respectively, that trailed estimates in the adopted budget. In California, PIT revenues were $3.5 billion lower than projections for December. January collections, while favorable to the budget, fell about 9% below the revised Department of Finance estimates included in the executive budget for FY 2019-20.
Financial market volatility, particularly during Q4 2018, which likely created capital losses and shifts in tax payments, could underlie the reasons for the revenue misses. Over the next few months (April, in particular) impacted states could recoup earlier declines. We continue to monitor the forces that may influence all state revenues. The future budget trajectory is a part of our analytical framework and helps inform decisions for our portfolio exposures.
What is City National Rochdale’s investment outlook for 2019?
Given our positive assessment of the fundamental backdrop, we remain bullish on equities in general for 2019 and continue to see attractive prospects in the opportunistic fixed income class. Still, we believe investors should prepare for more moderate returns and continued volatility in the year ahead.
The investment landscape has grown more challenging as investors adjust to more typical late-stage expansion conditions of higher inflation, rising interest rates and less accommodative monetary policy.
Meanwhile, concerns over global growth, trade tensions and other geopolitical risks, mean markets will likely continue to be subject to periodic swings in sentiment and potential pullbacks. None of this means 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.
Our equity and fixed income research teams have made deliberate risk-mitigating changes to help fortify client portfolios against the type of turbulence we have recently experienced, while leaving them well positioned to take advantage of opportunities should they present themselves.